4000 - Advisory Opinions
Investment of Idle Custodial Funds in Repurchase Agreements by Agencies Selling Livestock on Commission Basis for Department of Agriculture
August 25, 1993
Gerald J. Gervino, Senior Attorney
You have received several requests by agencies selling livestock on a commission basis for permission to invest their idle custodial funds in repurchase agreements ("repos") through their depository banks.
Your office is responsible for oversight of the regulations issued under the Packers and Stockyards Act, 1921, 7 U.S.C. §§ 181-229 (1988) ("Packers Act''), pertaining to custodial accounts. All market agencies selling livestock on a commission basis are required by 9 CFR § 201.42 (1992), to establish and maintain a bank account entitled "Custodial Account for Shippers' Proceeds." The custodial account must be maintained in an FDIC insured bank.
The Packers Act allows market agencies to invest idle funds resulting from so-called "float" in interest-bearing savings accounts and/or certificates of deposit. The investment must be properly identified as part of the custodial account and maintained in the same bank. Custodial funds must not be invested where there is a risk of loss of the principal or where the investment activity does not clearly show that the "Custodial Account for Shippers' Proceeds" is the sole owner of the investment.
Recently you have received several requests by market agencies for permission to invest their idle custodial funds in "repurchase agreements" ("repos") through their depository banks. You have several questions with respect to the consequences of market agencies transferring custodial funds from bank accounts to repos.
Before we answer your specific questions, we would like to mention a few legal relationships. We consider a repo to be a "transfer" of a security or other asset from one or more parties to two or more parties with an obligation on the part of the transferor to "repurchase" the security at a time and under the terms specified in the repurchase contract. Even if issued by a bank, it is not a deposit and it is not insured by the FDIC.
Instead it is classified as a secured loan, collateralized by the "transferred" security. Any failure of the obligor on the repo or any failure to realize upon the underlying security would not be the responsibility of the FDIC.
You specifically ask:
1. In the event of a bank failure and subsequent takeover by FDIC, how is the trust nature of the custodial account affected when funds have been continually passed between the custodial account and a repo investment?
While funds are on deposit in the bank and credited to the custodial account, the beneficial owners will be insured in accordance with their respective interests, if the account meets the standards previously discussed in our letters. Funds taken from the custodial account and invested in repos upon which third parties are obligated would be treated similarly to third party securities of which the bank has custody. The bank's receiver would be obligated to transfer the repo to the market agent or its designee.
Funds taken from the custodial deposit account and invested in repos issued by the bank would be treated as secured obligations of the bank. The investors would be uninsured bank creditors whose interests are established in a secured claim with the receiver they might, for example, receive liquidation dividends upon either the liquidation of the underlying security or upon payment of a common claim against the receivership estate.
2. What happens to repos and the underlying securities in the event of a bank failure and a subsequent takeover by FDIC?
As briefly mentioned in our answer to question one, the FDIC would regard the repos either as third party securities held in a custody arrangement for the bank customer or as uninsured obligations of the bank. In neither case is the FDIC involved as insurer of bank depositors. As receiver for a closed bank, the FDIC would normally transfer custodial securities, such as a third party repo, to the bank customer/owner of the security. Where the closed bank is obligated upon a repo, the customer's claim would be recognized against the receivership estate and entitle the customer to appropriate liquidation dividends, if any. The repo purchaser might also realize upon the underlying security if the purchaser has a perfected security interest in the underlying securities under State Law.
3. What would be the expected time frame for liquidation of the securities pursuant to a bank failure?
Most insured depositors receive their insurance proceeds within a week or so of a bank closing. Securities held in custody may take longer to return to or transfer for a customer, because the obligation is not the FDIC's own and is part of an often complex estate requiring inventory and evaluation. Because the size and complexity of bank receivership estates and the state of the closed bank's records vary so greatly, we cannot provide a precise timetable.
4. Could there be any problems that would cause a delay in the liquidation/distribution of the securities?
Yes. To list problems of this nature would probably mean listing all of the ailments that could cause a bank to close. We cannot do this. We would like to note that securities of third parties are usually returned to or transferred for bank customers without mishap. Uninsured obligations of the bank itself, such as bank issued repos, would normally be the subject of liquidation dividends, which can involve substantial delays.
If you have any further questions, please write or call me at (202) 898-3723. My Fax number is (202) 898-3715.