Issuing FDIC-Guaranteed Senior Debt Under the Debt Guarantee Program: A Practical Guide

Corporate & Securities February 27, 2009 Issuing FDIC-Guaranteed Senior Debt Under the Debt Guarantee Program: A Practical Guide by Rodney R. Peck, Patricia F. Young and Nathan D. Cardozo Under the FDIC s Debt Guarantee Program, the FDIC will temporarily guarantee newly issued senior unsecured debt by certain qualified financial institutions. This Client Alert will discuss the elements of the Debt Guarantee Program and provide practical guidance to prospective issuers. Background On November 21, 2008, the Federal Deposit Insurance Corporation ( FDIC ) published the Final Rule for the FDIC s Temporary Liquidity Guarantee Program ( TLGP ). Originally announced in October 2008, the TLGP s goal is to strengthen confidence and encourage liquidity in the banking system by guaranteeing newly issued senior unsecured debt of banks, thrifts, and certain holding companies, and by providing full coverage of non-interest bearing deposit transaction accounts, regardless of dollar amount. 1 The TLGP consists of two parts, a Debt Guarantee Program ( DGP ) and a Transaction Account Guarantee Program 2. Under the DGP, the FDIC will temporarily guarantee newly issued senior unsecured debt by certain qualified financial institutions. Eligible issuers had until December 5, 2008 to decide whether to participate in either or both of the TLGP programs, and to opt-out if they chose not to. Terms of the DGP Under the DGP, the FDIC fully guarantees all newly issued, fixed- or floating-rate senior unsecured debt with a maturity greater than 30 days, issued by certain eligible issuers, up to certain limits and with certain 1 2 FDIC: Temporary Liquidity Guarantee Program; Final Rule; 12 C.F.R. Part 370; Temporary Liquidity Guarantee Program, 73 Fed. Reg. 7224 (Nov. 26, 2008). Under the Transaction Account Guarantee Program, the FDIC will temporarily provide unlimited deposit insurance to guarantee funds held in certain interest and non-interest bearing transaction accounts at FDIC-insured institutions. Specifically, non-interest bearing accounts such as payroll accounts, traditional checking accounts, official checks and non interest escrow accounts, as well as IOLTA (Interest On Lawyer Trust Accounts) and NOW (Negotiable Order of Withdrawal) accounts, will be fully insured by the FDIC through December 31, 2009. 12 C.F.R. 370.4. Pillsbury Winthrop Shaw Pittman LLP www.pillsburylaw.com Volume 0804, No. 8070 1

exceptions discussed below. The FDIC s guarantee extends only to debt issued on or after October 14, 2008, through and including October 31, 2009, and terminates at the earlier of maturity or June 30, 2012. 3 For debt that falls within the DGP, the implications are significant. Because the FDIC s guarantee is full and unconditional, the debt is backed by the full faith and credit of the United States government. Eligible Issuers Eligible issuers under the DGP include all FDIC-insured depository institutions, all U.S. bank holding companies and financial holding companies, and all U.S. savings and loan holding companies which either engage only in activities that are permissible for financial holding companies to conduct under section (4)(k) of the Bank Holding Company Act of 1956, as amended ( BHCA ) (essentially financial-related activities), or that have at least one insured depository institution subsidiary that is the subject of an application that was pending on October 13, 2008, pursuant to section 4(c)(8) of the BHCA. 4 U.S. bank subsidiaries of foreign bank holding companies are eligible to issue FDIC-guaranteed debt under the DGP. Affiliates of FDIC-insured depository institutions may also request that the FDIC designate them as eligible entities. 5 When the TLGP was announced, as part of the Final Rule, the FDIC gave eligible issuers until December 5, 2008 to decide whether they were going to participate in the DGP. Eligible issuers that did not opt out by that date are bound by the terms of the program for all eligible debt they issue up to a specified limit (discussed below) and cannot issue new senior unsecured debt outside the DGP. 6 There is a limited exception, however, for eligible issuers that elected the so-called long-term non-guaranteed debt option on or before the opt-out deadline of December 5, 2008. 7 Those that elected this option, and paid a nonrefundable fee to the FDIC, can at any time issue non-fdic-guaranteed unsecured senior debt which would otherwise fall under the DGP, so long as that debt has a maturity date after June 30, 2012. 8 Eligible Debt As currently enacted, the DGP guarantees all newly issued, senior unsecured debt with a maturity of one month or more issued until October 31, 2009, through June 30, 2012. 9 (Originally, the cut-off date for issues under the DGP was June 30, 2009, but the FDIC, along with the Treasury Department, the FRB, the OCC and the OTS, in a Joint Statement dated February 10, 2009, announced that they will be extending the program through October 31, 2009, for an additional premium. 10 ) Separately, the success of the DGP has led the FDIC to discuss extending the length of the guarantee as well, possibly to 2019. 11 The FDIC has not formally adopted either of these modifications as of the date of this writing. 3 4 5 6 7 8 9 Note that the U.S. Treasury Department, the FDIC, the Board of Governors of the Federal Reserve System (the FRB ), the Comptroller of the Currency (the OCC ) and the Office of Thrift Supervision (the OTS ) in a Joint Statement issued on February 10, 2009, announced that they would be extending the June 30, 2009 cut-off date for issues under the DGP to October 31, 2009. FDIC: Temporary Liquidity Guarantee Program Frequently Asked Questions. See http://www.fdic.gov/regulations/resources/tlgp/faq.html; 12 C.F.R. 370.2. Id. Note that, except in the limited circumstance where two issuers that chose differently during the opt-out period later merge, the opt-out was a one-time choice. If an issuer chose to opt out during the opt-out period, it will not be allowed to opt back in. 12 C.F.R. 370.5. 12 C.F.R. 370.3(d). Id. 12 C.F.R. 370.3 10 See Joint Statement: Financial Stability Plan (February 10, 2009), http://www.fdic.gov/news/news/press/2009/pr_fsb.html. 11 See FDIC Press Release dated January 16, 2009, http://www.fdic.gov/news/news/press/2009/pr09004.html. Pillsbury Winthrop Shaw Pittman LLP www.pillsburylaw.com Volume 0804, No. 8070 2

The FDIC, in the Frequently Asked Questions accompanying its Final Rule, provided a non-exclusive list of the types of debt covered by the DGP, including: federal funds purchased; promissory notes; commercial paper; unsubordinated unsecured notes, including zero-coupon bonds; U.S.-dollar-denominated certificates of deposit owed to an insured depository institution, an insured credit union, or a foreign bank; U.S.-dollar-denominated deposits in an international banking facility of an insured depository institution owed to an insured depository institution or a foreign bank; and U.S.-dollar-denominated deposits on the books and records of foreign branches of U.S. insured depository institutions that are owed to an insured depository institution or a foreign bank. 12 Specifically excluded from the guarantee coverage under the DGP are obligations from guarantees, or other contingent liabilities, derivatives, derivative-linked products, convertible debt 13, capital notes, negotiable CDs, and structured notes. 14 Also excluded from the DGP are retail debt securities, i.e., securities marketed exclusively to retail investors and debt owed to affiliates and insiders. 15 Under the DGP, the FDIC will guarantee debt up to 125% of an institution s senior unsecured debt that was outstanding as of September 30, 2008 (excluding debt to affiliates, but including short-term debt), maturing on or before June 30, 2009. 16 If an otherwise eligible insured depository institution had no outstanding senior unsecured debt as of September 30, 2008, the limit is 2% of its consolidated liabilities as of that date. 17 Participating entities that are not FDIC-insured depository institutions, such as holding companies, and that had no outstanding senior unsecured debt as of September 30, 2008, must seek FDIC approval before issuing new debt that is to be guaranteed. 18 Any debt issued by an institution in excess of that institution s DGP limit is not covered by the DGP and may not be identified as such. 19 An institution may request that the FDIC raise its DGP limit at any time by letter to the FDIC and appropriate federal banking agency. 20 In making the determination whether to increase the limit, the FDIC will consider the financial condition and supervisory history of the eligible entity. 21 If, for any reason, an institution in fact identifies debt which exceeds its DGP limit as FDIC-guaranteed, that institution will be subject to an additional assessment of up to 100% of the assessment already paid on its outstanding FDIC-guaranteed debt. 22 Further, any such circumstance would potentially subject the 12 13 14 15 16 See FDIC: Temporary Liquidity Guarantee Program Frequently Asked Questions, http://www.fdic.gov/regulations/resources/tlgp/faq.html. Note, however, that on Friday, February 27, 2009, the FDIC voted to amend the TLGP Rule to allow eligible issuers to apply to have the FDIC guarantee newly issued senior unsecured debt with a feature that mandates conversion of the debt into common shares of the issuing entity at a specified date no later than the expiration date of the FDIC s guarantee. The amendment will only apply to new debt, and will not retroactively guarantee existing debt. The purpose of the amendment is to allow eligible issuers to attract additional, long-term funding. See, FDIC Modification of Temporary Liquidity Guarantee Program, Draft Interim Rule http://www.fdic.gov/news/board/27feb09_interim_rule_tlgp.pdf; US bank regulator expands debt guarantee program, http://www.forbes.com/feeds/reuters/2009/02/27/2009-02- 27T154907Z_01_N27335984_RTRIDST_0_FINANCIAL-BANKS-DEBT-URGENT.html. 12 C.F.R. 370.2(e)(5). Id. Note that debt that is more broadly marketed, even if subsequently held by retail investors through secondary market trading, should still qualify under the DGP. See FDIC: Temporary Liquidity Guarantee Program Frequently Asked Questions, http://www.fdic.gov/regulations/resources/tlgp/faq.html#debt. 12 C.F.R. 370.3(b)(1). 17 12 C.F.R. 370.3(b)(2). 18 12 C.F.R. 370.3(b)(3). 19 12 C.F.R. 370.3(b)(7). 20 12 C.F.R. 370.3(h). 21 12 C.F.R. 370.3(h)(3). 22 12 C.F.R. 370.6(e). The FDIC may reduce the additional assessment upon a showing of good cause. Pillsbury Winthrop Shaw Pittman LLP www.pillsburylaw.com Volume 0804, No. 8070 3

institution to an FDIC enforcement action, including civil money penalties, termination of FDIC insurance and individual actions against any persons who knowingly misrepresented the debt as FDIC-guaranteed. 23 The FDIC has not imposed limitations on the use of the funds raised in FDIC-guaranteed issuances under the DGP, with one major exception. The debt may not be used to pre-pay pre-existing senior debt. 24 It can be used to pay debt as it comes due. Terms of the Guarantee All debt issued under the DGP is subject to the terms contained in the Master Agreement required to be entered into by the issuer with the FDIC no later than 10 days after that issuer s TLGP election, which in any case, could not have been later than December 15, 2008. The Master Agreement limits debt to unsecured borrowing, evidenced by written agreement, with specified and fixed principal; it must be noncontingent and non-callable, it must not be subordinated, and it cannot contain options or other embedded derivatives or be bundled with other securities. 25 The FDIC has imposed a reporting requirement and an assessment for issuers which have not opted out of the DGP. For each issuance of DGP guaranteed debt issued after December 5, 2008, the issuer must notify the FDIC within 5 days of the issuance via the FDIC s online FDICconnect service. 26 Further, pursuant to the Master Agreement, eligible issuers which have not opted-out of the program must make monthly reports to the FDIC of all guaranteed debt then outstanding. Each such report must be certified by the institution s Chief Financial Officer or equivalent, and the first such report must include a statement of the institution s DGP limit. 27 Issuers are also required to pay an assessment to the FDIC for all FDIC-guaranteed debt they issue under the DGP. Fees are calculated by multiplying the amount of FDIC-guaranteed debt times the term of the debt (expressed in years) times an annualized assessment rate of between 50 and 100 basis points based on the maturity date. 28 Implications of Issuing Debt Under the DGP Practical Considerations While there was some initial uncertainty regarding how FDIC-guaranteed debt under the DGP should be treated under the federal securities laws, the Securities and Exchange Commission ( SEC ) and the FDIC moved quickly to provide clarification. By a no-action letter, dated November 24, 2008, in response to a request from the FDIC, the SEC confirmed that it considers debt issued under the DGP to be guaranteed by the United States government or an instrumentality thereof for the purposes of Section 3(a)(2) of the Securities Act of 1933 (the Securities Act ), and, therefore, exempt from registration under the Securities Act as, in effect, a U.S. government security. 29 23 12 C.F.R. 370.11(b). 24 25 12 C.F.R. 370.3(e)(1). See TLGP Master Agreement, http://www.fdic.gov/regulations/resources/tlgp/master.pdf. 26 Temporary Liquidity Guarantee Program Debt Guarantee Program - Debt Instrument Reporting, FIL-139-2008 (December 8, 2008), http://www.fdic.gov/news/news/financial/2008/fil08139.html. 27 28 29 See id.; TLGP Master Agreement, http://www.fdic.gov/regulations/resources/tlgp/master.pdf. 12 C.F.R. 370.6(d); FDIC: Temporary Liquidity Guarantee Program Frequently Asked Questions, http://www.fdic.gov/regulations/resources/tlgp/faq.html. Response of the Office of Chief Counsel, Division of Corporate Finance, November 24, 2008, http://www.sec.gov/divisions/corpfin/cf-noaction/2008/fdic112408.htm. Pillsbury Winthrop Shaw Pittman LLP www.pillsburylaw.com Volume 0804, No. 8070 4

The availability of the Section 3(a)(2) exemption should enable eligible issuers to gain access to the public debt markets more easily and less expensively than if they were to issue debt in an offering registered with the SEC under the Securities Act. Senior debt subject to the FDIC guarantee can be issued without SEC registration and the payment of related registration fees. Also, a Section 3(a)(2) exempt offering of FDICguaranteed debt is subject to liability under Rule 10b-5 of the Securities Act of 1934, as amended (the Exchange Act ), and Section 17 of the Securities Act only for intentional fraud or deceit (scienter) for making untrue statements of material fact or material omissions. A registered offering of debt, on the other hand, includes the potential of Securities Act Section 11 and Section 12(a)(2) liability, a stricter liability standard, for the registration statement and the prospectus. While national banks are generally required to register their securities with the OCC under 12 C.F.R. Part 16 30, Section 16.5(a) thereof exempts securities from registration when those securities are exempt from registration under Section 3 of the Securities Act but only by reason of an exemption other than the exemption for bank-issued securities and Section 3(a)(11) of the Securities Act (exemption for intrastate offerings). 31 By an Interpretive Letter dated January 26, 2009, the OCC has confirmed that this exemption from registration under Section 16.5(a) is applicable to FDIC-guaranteed senior unsecured debt issued by a national bank under the DGP, as such securities are exempt from registration due to the guarantee by an instrumentality of the United States, provided that such debt matures on or before June 30, 2012. 32 While the FDIC and the OTS have not yet issued a formal ruling with respect to banks or thrifts within their jurisdictions, we believe that these agencies will take positions consistent with that of the OCC. All three major rating agencies have announced that they will give FDIC-guaranteed debt the same rating as they give to debt of the United States government itself. As long as newly issued senior unsecured debt qualifies for the DGP, Moody s Investors Service will assign it backed-aaa and backed-prime 1 ratings, Fitch Ratings will assign it a AAA/F1+ rate and Standard & Poor s will assign long-term debt a AAA rating and short-term debt an A-1+ rating. 33 There is also an advantage to issuing FDIC-guaranteed debt in a case where a securities broker-dealer affiliate of the issuer will participate in the offering. As a general matter, if an affiliate of a Financial Industry Regulatory Authority ( FINRA ) member issues securities in a public offering, and the FINRA member plans to participate in the distribution, even if the securities would otherwise be exempt from the filing requirements of FINRA Rule 5110 (the corporate financing rule), a filing would need to be made with FINRA and a no objections letter as to compensation to the affiliate would need to be obtained. 34 In addition, FINRA generally requires issuers to comply with NASD Rule 2720 (the conflict of interest rule), which requires a qualified independent underwriter ( QIU ) to render an opinion on pricing, conduct due diligence and participate in the preparation of the offering circular when a member participates in the distribution of its own securities or those of an affiliate. 35 There is an exception under NASD Rule 2720(c)(3)(C) for proposed investment grade securities, those of a class likely to be rated Baa or better 30 31 32 33 34 35 12 C.F.R. 16.3(a). 12 C.F.R. 16.5. See Comptroller of the Currency, Interpretive Letter 1108, dated January 26, 2009, http://www.occ.treas.gov/interp/jan09/int1108.pdf. See, e.g., The Counterintuitive Upside to Morgan Stanley s Debt Issues, February 17, 2009 (discussing the rating of a recent FDIC-guaranteed issuance by Morgan Stanley), http://industry.bnet.com/financial-services/1000414/upside-to-morgan-stanley%e2%80%99s-notes/. FINRA Rule 5110: Corporate Financing, http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=6831. NASD Rule 2720: Distribution of Securities of Members and Affiliates Conflicts of Interest, http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=3676. Pillsbury Winthrop Shaw Pittman LLP www.pillsburylaw.com Volume 0804, No. 8070 5

by Moody's or Bbb or better by Standard & Poor s. 36 Additionally, under both Rule 5110 and Rule 2720, exempted securities as defined in Section 3(a)(12) of the Exchange Act, including obligations guaranteed as to principal or interest by, the United States, 37 are likewise exempt from all the requirements of these two rules, including filing and QIU provisions. 38 Because FDIC-guaranteed debt is fully and unconditionally backed by the federal government, it should fall within the exemption, and issuers need not comply with FINRA Rule 5110 or NASD Rule 2720. An additional implication of the Section 3(a)(2) exemption from Securities Act registration is that FDICguaranteed debt is not eligible for TRACE (Trade Reporting and Compliance Engine) reporting. Established by FINRA, TRACE is a secondary reporting system for the trading of corporate bonds. However, because debt issued under the DGP is exempt from SEC registration, and exempt from FINRA rules, it is not eligible to be tracked by TRACE. 39 As a result, there might not be the same transparency regarding secondary trading of FDIC-guaranteed debt as typically would be the case for registered securities. Significantly, the market convention is developing towards relatively simplified offering circulars. Specifically, the offering circular for a Section 3(a)(2) exempt offering of FDIC-guaranteed debt is likely to mention the Call Reports of the issuing bank and the SEC filings of its parent holding company, but not incorporate such documents by reference. In addition, such offering circulars will generally include limited selected financial data of the bank and its parent but little business description and no Management s Discussion and Analysis of Financial Condition ( MD&A ). While all material facts, of course, should be disclosed in the offering circular, what is material depends on the context, and, given the presence of the FDIC guarantee, one can more readily conclude that the disclosures may be limited. Key disclosures would include a description of the DGP, the terms of the debt securities and the FDIC s guarantee, as well as a discussion of tax and ERISA considerations. The Final Rule itself requires only that each eligible issuer that did not opt out include a legend discussing the terms of the FDIC guarantee for debt under the DGP 40 and a legend disclaiming the FDIC guarantee for debt issued outside of the DGP. 41 Finally, it is our understanding that several recent transactions have been consummated without a disclosure opinion of legal counsel, an opinion as to the validity of the FDIC guarantee, or an auditor's comfort letter. Also, due diligence can be expected to be more limited than in the case of a non-fdicguaranteed debt offering (i.e., focused on the eligibility of the issuer and the debt for the FDIC s guarantee under the DGP, use of proceeds in compliance with the DGP, etc.). 36 37 38 39 Id. at 2720(c)(3)(C). 15 U.S.C. 78c(a)(42). 15 U.S.C. 78c(a)(12). FINRA Rule 6200 et seq. 40 This debt is guaranteed under the Federal Deposit Insurance Corporation s Temporary Liquidity Guarantee Program and is backed by the full faith and credit of the United States. The details of the FDIC guarantee are provided in the FDIC s regulations, 12 CFR Part 370, and at the FDIC s website, www.fdic.gov/tlgp. The expiration date of the FDIC s guarantee is the earlier of the maturity date of the debt or June 30, 2012. 12 C.F.R. 370.5(h)(2). 41 This debt is not guaranteed under the Federal Deposit Insurance Corporation s Temporary Liquidity Guarantee Program. 12 C.F.R. 370.5(h)(3). Pillsbury Winthrop Shaw Pittman LLP www.pillsburylaw.com Volume 0804, No. 8070 6

Client Alert Corporate & Securities For further information, please contact: Rodney R. Peck (bio) San Francisco +1.415.983.1516 rodney.peck@pillsburylaw.com Patricia F. Young (bio) San Francisco +1.415.983.1845 patricia.young@pillsburylaw.com This publication is issued periodically to keep Pillsbury Winthrop Shaw Pittman LLP clients and other interested parties informed of current legal developments that may affect or otherwise be of interest to them. The comments contained herein do not constitute legal opinion and should not be regarded as a substitute for legal advice. 2009 Pillsbury Winthrop Shaw Pittman LLP. All Rights Reserved. Pillsbury Winthrop Shaw Pittman LLP www.pillsburylaw.com Volume 0804, No. 8070 7