Authority of State Banks to Invest in Trust Preferred Securities
The Federal Deposit Insurance Corporation (FDIC) has recently received numerous requests for clarification about the extent of a state bank's ability to invest in "trust preferred securities," which are hybrid instruments possessing characteristics typically associated with debt obligations. Several insured state nonmember banks have asked whether section 24 of the Federal Deposit Insurance Act (12 U.S.C. § 1831a) or the FDIC's implementing regulations (12 C.F.R. Part 362) impose limits on the authority of a state nonmember bank to invest in trust preferred securities.
Section 24 and Part 362 do not restrict an insured state bank's authority under state law to invest in trust preferred stock, provided the stock meets the investment quality and marketability requirements applicable to "investment securities" under the Office of the Comptroller of the Currency's (OCC) securities regulations (12 C.F.R. Part 1). The OCC has stated that national banks are permitted to invest in trust preferred stock as "Type III" investment securities (OCC Interp. Letter No. 777, April 8, 1997). Also, section 24(a), governing activities permissible for a national bank, does not incorporate amount limits applicable to a national bank activity. Therefore, state nonmember banks are not subject to the 10-percent-per-issuer diversity limit that applies to a national bank's investment in Type III securities.
Trust preferred stock investments also are not subject to the 15 percent of capital limit in section 362.3(b)(2)(iii). The discussion of trust preferred stock in the preamble to the FDIC's recent revisions to that section also was only for informational purposes. The revised section is similar to the version of Part 362 adopted in 1992, in that it authorizes a state bank to invest a total of 15 percent of "Tier 1" capital in two other types of hybrid securities, adjustable rate preferred stock (ARPS) or money market preferred stock (MMPS). In adopting section 362.3(b)(2)(iii), the FDIC added a new provision authorizing the FDIC to designate other kinds of hybrid securities as permissible investments, subject to the same 15 percent cumulative limit, if the securities have the character of debt securities and do not represent a significant risk to the deposit insurance funds. This provision permits the FDIC to respond to the financial markets in the future, which continually develop new financial products in response to investor and client needs. Trust preferred securities were identified in the discussion only as an illustration of one such recently developed product.
State nonmember banks also should note that since the Part 362 provisions authorizing investment in ARPS and MMPS were originally adopted, the OCC determined that a national bank is permitted to invest in MMPS as a Type III investment security (OCC Interp. Letter No. 781, April 9, 1997). Therefore, like trust preferred securities, section 24 and Part 362 do not restrict any authority an insured state bank holds under state law to invest in trust preferred stock, provided the stock meets the investment quality and marketability requirements applicable to investment securities under the OCC's securities regulations at 12 C.F.R. Part 1, without regard to the 10-percent-per-issuer diversity limit.
Finally, although there are no diversity requirements explicitly set out by federal statute or regulation when a state nonmember bank invests in trust preferred securities or MMPS that are otherwise permissible for a national bank, state and federal bank examiners will evaluate these investments as an element of the bank's investment portfolio during safety and soundness examinations. This evaluation is to ensure consistency with prudent banking practice and the bank's investment policy. The same is true for investments in ARPS and MMPS under section 362.3(b)(2)(iii) of Part 362, which does not directly address quality or diversity criteria. Affected institutions are also reminded of the Federal Financial Institutions Examination Council's "Uniform Agreement on the Classification of Assets and Appraisal of Securities Held by Banks," providing that an investment security that loses its investment rating, or an unrated security that drops below equivalent investment quality, will be classified.
For further information, please contact Curtis Vaughn (202-898-6759), Examination Specialist in the Division of Supervision, or Jamey Basham (202-898-7265), Counsel in the Legal Division.
James L. Sexton
FDIC-Supervised Banks (Commercial and Savings)
Insured Savings Associations
NOTE: Paper copies of FDIC financial institution letters may be obtained through the FDIC's Public Information Center, 801 17th Street NW, Room 100, Washington, DC 20434 (800-276-6003 or (703) 562-2200).