In the news this week
TIAA sells its bank, more on USDF, and some Volcker disclosures
What follows is an assorted collection of thoughts, some fairly well developed, others more speculative, on things related to bank regulation that stood out to me this week.
TIAA Sells Its Bank
On Thursday TIAA announced that it had reached a definitive agreement to sell nearly all of its existing banking operations to various investment funds.
Aligning with a long-term strategic plan to refocus on the company's retirement business and Nuveen, its asset manager, TIAA has entered into a definitive agreement to sell TIAA Bank to new investors with extensive experience in financial services. TIAA will retain a non-controlling ownership stake in the bank. Terms of the transaction are not being disclosed.
Under the agreement, which is subject to regulatory approvals, nearly all the bank's current assets and business lines will be acquired by the new ownership, with the exception of TIAA Trust, which currently is part of TIAA Bank but is closely aligned with the wealth business that complements TIAA's retirement organization and mission. TIAA will apply for a new, separate national trust bank charter, and the TIAA Trust business will become a subsidiary of TIAA.
The new investors that will each own non-controlling interests in the bank after the transaction closes are funds managed by Stone Point Capital, Warburg Pincus, Reverence Capital Partners, Sixth Street and Bayview Asset Management.
There may be at least two interesting bank regulatory aspects to this story.
Insurance depository institution holding companies continue to exit banking
The Federal Reserve Board is required to establish minimum leverage and risk-based capital requirements for depository institution holding companies, including depository institution holding companies that are significantly engaged in insurance activities. Applying capital requirements to insurance firms that own banks has been a complicated endeavor for the Board,1 and such rules are still not finalized. They may, however, already be having an effect.
In June 2016 the Federal Reserve Board issued an advance notice of proposed rulemaking seeking input on “conceptual frameworks that could apply to systemically important insurance companies and to insurance companies that own a bank or thrift.” At the time, the Board described the universe of such firms as follows:
The Board currently supervises twelve insurance depository institution holding companies and two systemically important insurance companies. Collectively, these firms have approximately $2 trillion in assets and represent approximately one quarter of the assets of the U.S. insurance industry. These institutions range in size from approximately $3 billion in total assets to about $700 billion in total assets, and engage in a wide variety of insurance and noninsurance activities. Some of the firms operate exclusively in the United States, and some have material international operations.
Around three years later, the Board issued a proposed rule setting out what it called the “Building Block Approach” to capital requirements for insurance depository institution holding companies. By that time, the number of such companies had shrunk to eight, and the two systemically important insurance companies were no longer designated as such. A Reuters story from the time lists the in-scope firms for the proposed rule as USAA, TIAA, State Farm, Ameriprise, AAA, Mutual of Omaha, Ohio Farmers and First American.
Since then, the number of insurance companies subject to the Board supervision has continued to dwindle, as both State Farm and Mutual of Omaha sold their banking operations. In addition, Ameriprise is pursuing a change in charter that, if approved, would mean it too would no longer be supervised by the Board or subject to its capital rules.
All this means that if the TIAA transaction closes as expected, by 2023 there may be only four (or fewer) insurance depository institution holding companies subject to the Board’s supervision and the Building Block Approach capital rule, if finalized: three pretty small firms, at least in terms of banking assets, and a somewhat larger one in USAA.
It probably is not right to say that all or even most of this is being driven by the prospect of becoming subject to consolidated capital requirements, and I have no idea what specifically drove TIAA to look to exit.2 At the same time, there are at least hints that the rules have played a role for some firms.3
Navigating the Control Rules
Of course, exiting the banking business may be more difficult than exiting other lines of business, given the Federal Reserve Board’s rules regarding when a company is viewed as controlling a bank. These rules, which the Board last revised in 2020, can sometimes mean that for bank regulatory purposes a company controls a bank, even if in other contexts an interest would not be viewed as anywhere close to controlling.
In its press release, TIAA says it will (1) retain a non-controlling interest in TIAA Bank and (2) continue to have ongoing business relationships with TIAA Bank, including through TIAA’s asset management business, Nuveen.
The press release does not provide further details, but I think the control rules mean that (1) TIAA will be able to hold no more than 14.9% of any class of TIAA Bank's voting securities and (2) depending on what the actual percentage is, TIAA's business relationships with TIAA Bank may need to be limited.
This is due to two separate presumptions in the control rules. First, the Board’s rules assume that if a company controls a bank and then seeks to divest control, the company will still be in a position to control the bank if it retains 15 percent or more of any class of the bank’s voting securities.4 Second, as shown in this visual, the control rules include various tiered presumptions relating to business relationships. The effect of these presumptions is that if a company owns a 5% or greater voting interest in a bank, it must limit its business relationships with the bank lest it be deemed for bank regulatory purposes to control the bank. The level of business relationships that are permissible without triggering a control presumption gets progressively lower as a company’s voting interest in the bank increases.
Does any of this matter here? Maybe not. It is not clear how much of the bank TIAA would have wanted to retain even in the absence of the control rules, and it could well be the case that TIAA has chosen to happily hold a less than 5% stake and maintain business relationships to whatever degree it wants.
The other wrinkle here, however, is who TIAA is selling to. Sometimes when you run into control issues, a relatively easy solution, from a regulatory perspective if not an economic one, is to have the investor with the control issue reduce its voting stake. This can be done, for example, by the investor that needs to remain below a certain voting threshold choosing to hold all or a portion of its interest in the form of non-voting securities, while the other investors continue to hold voting securities.
That relatively easy solution may not have been on the table here, though: TIAA’s press release says that the interests held by the new investors will also be non-controlling. In order to make that work, each investor will need to limit its own voting securities, and will need to avoid triggering other presumptions of control, such as those relating to director representation. The investors will also need to have structured the investment to avoid being viewed as acting in concert or as acting pursuant to agreements or understandings that for bank regulatory purposes are viewed as giving them control over securities held by their co-investors.
Based on the press release, everyone involved in this transaction is represented by very sophisticated counsel. As a result, I am sure the above control issues, as well as ones I have no doubt glossed over or misconstrued, have all been thought through in exacting detail. The point is not to suggest that anyone got anything wrong, but rather to note what may be an interesting dynamic to watch going forward.
Comments from USDF Consortium CEO
On Wednesday S&P Global Market Intelligence wrote about the OCC’s conditional approval of the Flagstar-NYCB bank merger, including the fact that the OCC is reviewing whether NYCB will be permitted to retain its equity interest in the USDF Consortium and its related holdings of Hash. This was discussed on this blog earlier this week, but new in the S&P article was a quote from the Consortium’s CEO:
"We view these conditions as consistent with the OCC's well publicized view that banks should receive prior approval before engaging in any activities related to digital assets or blockchain," said Rob Morgan, CEO of the USDF Consortium. "We always anticipated that moving forward, these types of new activities would require regulatory approval, and we remain committed to working with the banking agencies as we pursue those approvals."
This is completely fair with respect to NYCB, which through its merger with Flagstar is newly becoming a national bank. The OCC is therefore evaluating NYCB’s activities for the first time, and given that different statutes apply to national banks as compared to state chartered banks, it is not unreasonable for the OCC to want to take a fresh look, even if NYCB’s state regulator was comfortable with its activities.
It seems to me though that this quote potentially underplays the statement elsewhere in the OCC’s order that the OCC is also reviewing the permissibility of an existing national bank’s investment in the Consortium. That too could be no big deal and completely consistent with the OCC’s view that prior approval is required before engaging in digital asset activities.5 On the other hand, the Consortium was first announced publicly in January and it's not clear how long this other notification has been pending. At some point it will become fair to ask what is taking so long.
Volcker Illiquid Funds
The Volcker Rule prohibits, among other things, certain investments in hedge funds and private equity funds, referred to as covered funds. Banking organizations that made investments in covered funds generally had until July 2017 to conform certain legacy covered fund investments that were no longer permissible.
Special rules potentially applied, however, to certain funds that were principally invested in illiquid assets. These funds, by statute, could be eligible for a further extension of the conformance period for up to an additional five years. In December 2016 the Federal Reserve Board issued a statement of policy explaining how banking organizations could apply for such extensions. Thereafter, many banking organizations ultimately applied for, and were granted, extensions of the conformance period through July 2022, or such shorter date as determined by the Board.
In its Q2 10-Q filed in July, Goldman Sachs stated that it had achieved compliance by the deadline.
The Board of Governors of the Federal Reserve System (FRB) extended the conformance period to July 2022 for the firm’s investments in, and relationships with, certain legacy “illiquid funds” (as defined in the Volcker Rule) that were in place prior to December 2013. As of June 2022, the firm’s total investments in funds at NAV of $3.05 billion included $183 million of investments in covered funds for which compliance with the Volcker Rule was required by July 2022. The firm has achieved such compliance through the restructuring of these funds as liquidating trusts.
The Q3 10-Q filed this week by Goldman, however, is a little different. The sentence I bolded in the second quarter 10-Q excerpt above has been deleted, and the disclosure now reads instead:
As of September 2022, the firm’s total investments in funds at NAV included investments of approximately $400 million (net of the firm’s share of cash in the funds) in certain legacy “illiquid funds” (as defined in the Volcker Rule) for which the firm conformed by restructuring these funds to be non-covered funds as liquidating trusts by July 2022. However, based on recent interpretations of the covered fund provisions of the Volcker Rule, the firm may be required to seek an additional extension from the Board of Governors of the Federal Reserve System (FRB) to bring these funds into conformance. If the firm does not receive any required extensions or conform by the end of any extensions received, the firm may be required to sell such interests. If that occurs, the firm may receive a value for its interests that is less than the then carrying value as there could be a limited secondary market for these investments and the firm may be unable to sell them in orderly transactions.
Unless you read this as saying that Goldman’s own interpretations of the covered fund provisions have changed, this suggests to me that Goldman took an interpretative view with which the Federal Reserve Board disagreed.
Not quite in the same category but fitting a similar theme are the disclosures from Goldman’s peers at Morgan Stanley, which also indicate that illiquid fund conformance efforts are ongoing.6
I am skeptical that much of a regulatory purpose would be served by requiring divestiture of these interests now as opposed to next year or at some other later date,7 so my discussion of this should not be interpreted as claim that the firm has been caught red handed in some dramatic act of malfeasance. Instead, as with the rest of the content on this blog, I just think it is an interesting bank regulatory story.
Two quotes from a prominent Senator may illustrate some of the difficulty:
“I want strong capital standards, but they have to make sense”
“The Federal Reserve must recognize the differences between the industries and ensure that institutions engaging in insurance are not held to the same capital requirements as traditional banks”
The Senator in question? Maybe not your first guess.
TIAA’s press release noted that in light of its decision to “refocus on retirement” it has concluded that “now is the appropriate time for TIAA Bank to begin a new chapter under new ownership.”
See, for instance, Ameriprise’s statement in the press release linked above that its pursuit of an ILC charter is part of an effort to “align capital frameworks across its businesses to compete more effectively and efficiently.” State Farm was unhappy with the building block approach proposal as well, although other factors likely also played a role in its decision to exit.
See pages 47-49 here. There is an exception to this rule if 50 percent or more of the outstanding securities are sold to an unaffiliated individual or company, but this exception would not on its face apply here because the Board describes the exception as applying only if that 50 percent or more stake is “controlled by a single unaffiliated individual or company,” and TIAA is not selling to a single company.
Technically a “written notification of the supervisory office’s non-objection.”
Morgan Stanley’s disclosures this year on this point:
10-K filed in February 2022: “The Volcker Rule also prohibits certain investments and relationships by banking entities with covered funds, as defined in the Volcker Rule, subject to a number of exemptions and exclusions. In addition, there is an extension until July 2022 for conformance for certain legacy covered funds.”
10-Q filed in May 2022: No update
10-Q filed in August 2022: “We requested and received additional time until July 21, 2023 to conform investments in certain legacy illiquid funds. As of June 30, 2022, the carrying value of our interests in these legacy funds, which is measured at NAV, was approximately $350 million.”
10-Q filed in November 2022: “The Volcker Rule prohibits certain investments and relationships by banking entities with covered funds, as defined in the Volcker Rule. We requested and received additional time until July 21, 2023 to conform investments in certain legacy illiquid funds. During the current quarter, we have continued our efforts to conform these illiquid funds by July 21, 2023, including but not limited to assessing alternative conformance options permitted under the Volcker Rule. As a result, as of September 30, 2022, we continued to estimate the fair value of our investments in such covered funds using the net asset value per share (“NAV”), which approximated $300 million.”
I am a bit confused about how an extension is a possibility, however, given that the Board’s policy statement from 2016 said that it interprets the statute as providing that “the Board may grant an extension for each fund only once and for any period up to 5 years.” I assume there must be something I am missing, given that as mentioned in the footnote above at least one other firm appears to have received a second extension pushing the compliance date out beyond 2022. Is the argument maybe that the provision of the statute giving the Board the authority to extend the conformance date for illiquid funds is not the sole source of the Board’s authority to grant conformance period extensions?