Old News

A Reg YY FAQ on HLA monetization, an OCC letter on whole business securitizations, and more

The blog returns from the summer holidays with a look at a miscellaneous collection of recent(ish) developments. There is no unifying theme to this post; the point is just to highlight a few things that looked interesting or that otherwise follow up on items previously discussed on this blog. In some cases the items discussed here have not yet received a ton of coverage elsewhere, but most of the time this is probably because the developments are not all that newsworthy in the first place.

1. New Reg YY FAQ on Monetization of HLA Under the Internal Liquidity Stress Test

Under the Federal Reserve Board’s Regulation YY, large banking organizations are required to conduct periodic internal liquidity stress tests (ILST) incorporating various scenarios.¹ The ILST results are then used to size a required liquidity buffer equal to the organization’s net stressed cash-flow need over a 30-day planning horizon. A banking organization must maintain unencumbered highly liquid assets (HLA) at least equal to the size of the buffer. For this purpose, HLA generally correspond to assets that qualify as high-quality liquid assets for purposes of the Liquidity Coverage Ratio rule, provided that the assets in question meet certain operational and other requirements, including a requirement that the banking organization is able to demonstrate the capability to monetize the HLA in question under each ILST scenario.

On August 13, the Federal Reserve Board published a new Q&A on its Frequently Asked Questions about Regulation YY page.² The Q&A asks:

Can a covered firm incorporate non-private market sources such as the Federal Reserve’s discount window, Standing Repurchase Facility (SRF), or Federal Home Loan Bank (FHLB) advances as monetization channels to demonstrate its capability to monetize a highly liquid asset (HLA) under each internal liquidity stress test (ILST) scenario, as required by Regulation YY?

The Board’s answer is a qualified yes.

Regulation YY does not prescribe how a covered firm demonstrates that it can monetize the HLA in its liquidity buffer under each of its ILST scenarios required under Regulation YY. A covered firm can incorporate the discount window, SRF, and FHLB advances into its ILST scenario analysis, as a supplement to private market monetization channels, including for the 30-day planning horizon. The Federal Reserve encourages firms to assess the full range of liquidity sources. Covered firms should sufficiently support their assumptions and should not rely exclusively on non-private market sources for their assumed method of monetization of any major asset class.

With regard to monetization capabilities, the Federal Reserve expects a covered firm to demonstrate that it can monetize a representative portion of its HLA, by asset class, in private markets through periodically conducting either actual (versus assumed) sales or repo transactions.

The final paragraph of the response goes on to stress that the purpose of this new Q&A is only to provide clarity on the Reg YY monetization requirement. The response “should not be viewed as an expansion of the assets that qualify for inclusion in a covered firm’s liquidity buffer.”

2. OCC Supervisory Letter on Whole Business Securitizations

In mid-July the OCC published a redacted version of a Supervisory Letter from May 2024. The letter, signed by the OCC’s Deputy Comptroller for Large Bank Supervision, addresses the treatment of certain exposures under both the standardized and advanced approaches of the current U.S. implementation of the Basel capital rules.

The exposures in question are described by the OCC as arising from a whole business securitization,³ summarized in the letter as follows (redactions and substitutions in original):

[ The Company ], a [ ] company, has transferred assets that generate [a significant majority] of its income into a special purpose vehicle ([ ] or SPV). The assets transferred include (1) [ service contracts ], (2) intellectual property (IP), (3) [ ] software [ ], and (4) [ physical assets including hardware ]. [ The Company ] no longer owns the [service contracts], but as the servicer of the contracts on behalf of the SPV, [the Company] continues to conduct the day-to-day operations associated with those contracts. As [the Company] enters into new [service contracts] with customers, [ the Company ] transfers these new [service contracts] to the SPV. The SPV issues notes to investors, including the Bank, to fund the transfer of the [service contracts] to the SPV ([transaction]).

The letter then addresses the question of whether a national bank may treat exposures to this whole business securitization as securitization exposures under the capital rules.

No, concludes the OCC, for multiple reasons, any one of which would be enough to rule out securitization treatment. First, a substantial amount of the underlying exposures held by the SPV are not financial exposures. Second, the performance of the exposures to the SPV is not dependent on the performance of the underlying exposures, but rather is “heavily dependent upon [the Company’s] continued ability to provide services under the [service contracts].” Third, the underlying exposures are, in economic substance, exposures owned by an operating company.

3. CFPB Director Chopra on Convenience and Needs

At the recent board meeting at which the FDIC voted to propose significant changes to its brokered deposits rules, the agency also voted to release a proposed rulemaking related to industrial banks.

In connection with that vote, CFPB Director Chopra issued a statement in support of the proposed rule in which he expressed concern about two applications to charter industrial banks that were subsequently withdrawn, one from General Motors and the other from Edward Jones.⁴

Some of Director Chopra’s concerns related to what he described as the proposed “monoline” business model of each of the proposed banks, and the risks he believed this sort of business model would pose to the Deposit Insurance Fund.

Director Chopra also questioned whether each of the proposed banks would have met the convenience and needs of their communities. Some of what Director Chopra had to say in relation to this factor is similar to the FDIC’s conception of it in the agency’s proposed policy statement on bank merger transactions from earlier this year,⁵ and thus may have implications beyond industrial bank applications.

With respect to the GM application, Director Chopra stated:

The applicant intended to exclusively serve the clients of a third party—the parent company, GM.

Consumers who purchased a Ford or some other automobile, for example, would have been unable to obtain auto financing from GM Financial Bank, even if they were creditworthy and preferred GM Financial Bank’s rates and customer service. The applicant would have also funded the loans predominantly through deposit products offered to customers and other parties affiliated with the parent company.

Second, even if the applicant had proposed to serve a sufficiently broad community, it would not have clearly filled an unmet need by providing a new product or service to customers. It would have simply continued the lending already being conducted by GM Financial, the existing nonbank financial company, and offered standard online deposit products.

Third, the applicant would not have improved upon an existing product or service. It sought to enjoy the lower cost of funding that comes from access to the public safety net. There was nothing in the application that assured that this subsidy would have benefited consumers, as opposed to accruing to the shareholders and executives.

And with respect to the Edward Jones application, Director Chopra stated:

The bank would not have served a sufficiently broad community. It would have exclusively served clients of Edward Jones. People or businesses with a brokerage account at a competitor of Edward Jones who preferred the customer service and rates of Edward Jones Bank would have been prohibited from accessing its security-based loans. Similarly, the deposit funding would have come from Edward Jones customers only.

Even if the applicant was willing to serve a sufficiently broad community, it was not clear that the bank would have filled an unmet need. Edward Jones already offers margin loans to its customers directly and can offer security-based loans through third party bank partnerships. In addition, it already offers deposit products to its customers through a third-party network.

Moreover, the application did not adequately demonstrate that existing products or services would be improved upon. It is totally unclear from the application how lower funding costs supported by the federal safety net would have benefited the community, as opposed to accruing to shareholders and executives.

4. Preemption Developments

Illinois Interchange Fee Prohibition Act

Last week a coalition of bank and credit union trade groups sued Illinois in federal court seeking to stop the Illinois Interchange Fee Prohibition Act (IFPA) from taking effect. The IFPA would prohibit the charging of interchange fees in Illinois with respect to the portion of a debit or credit card transaction attributable to taxes or gratuities.

The trade groups contend that the IFPA (1) is preempted as to national banks by the National Bank Act, (2) is preempted as to federal savings associations by the Home Owners’ Loan Act and (3) is preempted as to federal credit unions by the Federal Credit Union Act. And, the trade groups say, because Illinois has statutes that seek to maintain parity between state banks, state savings banks and state credit unions and their respective federally-chartered bank, savings association and credit union peers, if the law is preempted as to federally-chartered entities then it also cannot be applied to state-chartered entities. The trade groups also include an argument that, in addition to all the above, the IFPA is separately preempted as to debit-card transactions by the Durbin Amendment.

The case was just filed and so is at an early stage. The trade group brief is worth a read, though, because it offers one of the first looks at how arguments in favor of National Bank Act preemption arguments are being formulated following the Supreme Court’s decision earlier this year in Cantero.

Interest on Escrow Cases

Speaking of Cantero, by the end of the month we should get a look at the arguments parties intend to make against National Bank Act preemption in the interest-on-escrow cases that federal courts of appeal are now again considering.

In the Cantero case itself, now back before the Second Circuit, opening briefs from the plaintiff customers are due by August 26. Meanwhile, in the Conti case in the First Circuit, which had been paused while the Supreme Court considered Cantero, opening briefs from the plaintiff customers, who are represented by the same lead appellate counsel as the customers in Cantero, are due by August 29. (From what I can tell, the Ninth Circuit has not yet set a briefing schedule in the Kivett case.)

In a recent speech, Acting Comptroller of the Currency Michael Hsu stated that the OCC intended to “vigorously defend core preemption” while also seeking to “embrace and develop more nuanced analysis when applying Barnett.” It is not yet clear how, if at all, the OCC’s actions with respect to preemption as described by Acting Comptroller Hsu will be brought to bear in the cases discussed above.

5. Pension Fund Seeks Information from Federal Reserve Board In Relation to the Board’s Supervision of Credit Suisse

In late July the Employees Retirement System for the City of Providence brought an action under seal against the Federal Reserve Board. Some documents in the case, filed in the Southern District of New York, have now been unsealed and as it turns out the case is about whether the Board may withhold certain documents relating to its supervision of Credit Suisse.

The pension fund characterizes the issue like this:

Petitioner is the plaintiff in a stockholder derivative action pending in New York Supreme Court (the “NY Action”) that seeks to hold certain former Credit Suisse directors and executives (“Defendants”) accountable for breaching their fiduciary duties by failing to establish and oversee reasonable risk management processes at the bank’s New York-based operations. . . .

On behalf of the Federal Reserve, Defendants have withheld bank examination reports, interview transcripts, and hundreds of documents (comprising almost entirely of internal Credit Suisse communications) from production to Petitioner (collectively the “Withheld Information”). The Federal Reserve sweepingly claims that this information is exempt from disclosure based on the bank examination privilege (“BEP”) and law enforcement privilege (“LEP”).

The Federal Reserve cannot support its heavy burden to establish privilege. It has provided only conclusory support based on an incorrect legal standard and insufficient review. Based on a review of just 4% of the documents withheld by Credit Suisse, the Federal Reserve claims that all the Withheld Information constitutes BEP because it consists of (i) “communications between Credit Suisse and its supervisors,” or (ii) “internal Credit Suisse emails or documents which contain or would reveal” information designated as confidential by the Federal Reserve. Ex. K at 9. These criteria are patently wrong. . . .

A response is due from the Board by August 30.

6. Hawaiian Electric Explores Strategic Options for American Savings Bank, Takes Goodwill Charge

Last August this blog wrote about American Savings Bank, a subsidiary of Hawaiian Electric Industries, Inc.. The post looked at the quirks of U.S. bank regulatory history that led to an electric utility coming to own a depository institution.

In April 2024, Bloomberg reported that Hawaiian Electric was “working with advisers to weigh various options for the 35-branch bank, including a full or partial sale.” More recently, when it announced results for American Savings Bank in late July, Hawaiian Electric confirmed that “it has been undertaking a comprehensive review of strategic options for ASB.”

Hawaiian Electric also as part of that July release disclosed that, in connection with its review, “the bank recorded a non-cash goodwill impairment charge that reflects management’s analysis of our bank’s market valuation.” The company’s 10-Q filed on August 9 provides a few more details:

Goodwill is initially recorded as the excess of the purchase price over the fair value of the net assets acquired in a business combination and is subsequently evaluated at least annually for impairment. The Company has identified ASB as a reporting unit and ASB’s goodwill relates to past acquisitions and is ASB’s only intangible asset with an indefinite useful life. . . .

HEI and ASB have been undertaking a comprehensive review of strategic options for ASB. During the course of this process, HEI and ASB had determined it is more-likely-than-not that the fair value of ASB is less than its carrying value. In light of this, as part of its on-going goodwill evaluation and the change in circumstances, after performing the goodwill impairment test as of June 30, 2024, HEI and ASB determined the full amount of its goodwill was impaired. As a result of our June 30, 2024 impairment test we recorded a pretax goodwill impairment charge of $82.2 million for the three and six months ended June 30, 2024.

7. Jiko Group Enforcement Action

Jiko Group is a fintech that, unlike many U.S. fintechs, controls it own bank, having acquired Mid-Central National Bank in 2020.

The company is maybe best known for its solution that provides spendable T-bills to corporates, currently summarized on Jiko’s website as follows:

1. Seamless onboarding and KYC meets state-of-the-art tech that puts privacy and data security first.

2. Funds are received via wires or ACH – just like any bank account.

3. Funds are swept and automatically invested, rolled, and managed in T-bills backed by the full faith and credit of the US Government.

4. Assets are held by Jiko’s registered broker-dealer in custody at BNY Mellon – safely away from regional bank failures and other balance-sheet risks.

5. Accounts can process wires out, support bill-pay and card spending, or transfer 24/7 to other accounts on the Jiko network. T-bills are sold accordingly, and seamlessly.

In July, the Federal Reserve Board in its capacity as the supervisor of Jiko Group as a bank holding company brought an enforcement action against the company. The Board’s order does not take issue with Jiko’s business model, necessarily, but does state that an October 2023 exam and “more recent communications” have identified “significant deficiencies in the financial condition of the holding company, including capital planning, earnings, strategic planning, cash flow, and liquidity.”

I don’t think what is discussed below is the main takeaway from the Board’s order, but after the order was published I went to check out the financial statements filed by Jiko Group on Form FR Y-9C and there noticed something strange.

For the quarter ended March 31, 2024 (the latest quarter available at the time the enforcement action was released), Jiko Group reported a CET 1 capital ratio of negative 117.5%. The since-released FR Y-9C for the most recent quarter similarly shows a CET 1 capital ratio of negative 101.1%. Jiko Group’s other capital ratios, both risk based and leverage based, are above regulatory minimums.⁶

So what’s going on here? From just a math perspective, the issue is that CET 1 capital, to oversimplify, consists of common stock and surplus, plus or minus retained earnings and some other stuff. Jiko has around negative $75.5 million in retained earnings and, according to the Y-9C, has only around $11.4 million in common stock and surplus. So for bank regulatory purposes Jiko is regarded as having CET 1 capital of around negative $64 million.

But that explanation only raises another question — why hasn’t Jiko raised capital through common stock issuances sufficient to bring its CET 1 ratio to acceptable levels? The answer isn’t totally clear, but I think what may be happening here is that Jiko believes that certain capital instruments it has already issued ought to count as common equity for bank regulatory purposes but, currently at least, the Federal Reserve Board disagrees.

I base this inference on a note Jiko has included with its more recent Y-9C filings. The note, included on the second-to-last page of the filing, reads:⁷

The Fed is reviewing our matter that preferred stock should be treated similarly as common stock for tier 1 capital calculations.

The note also indicates that the amount in question is pretty significant, around $94.9 million as of the most recent filing — enough to be the difference between a negative CET1 capital ratio and a ratio that is positive and well in excess of the regulatory minimum.

By including this item in this post the intention is not to suggest that Jiko is in financial trouble.⁸ Nor, again, is it to suggest that this was the main thing (or even necessarily a thing) driving the Board’s enforcement action. It is just something I thought was interesting and cannot fully explain.

8. Summit National Bank Enforcement Action

In April this blog wrote about a Federal Reserve Board enforcement action against Mode Eleven, a small Wyoming bank holding company that at one time described itself as a “Banking-as-a-Service enabler that owns a national bank.”

The Board’s order identified a series of deficiencies in Mode Eleven’s operations, “including with respect to pursuit of the fintech business strategy, related to board oversight, capital, earnings, liquidity, risk management, and compliance with the rules related to affiliate transactions.” The order also stated that Mode Eleven “voluntarily ceased pursuit of the fintech business strategy and is winding down all related activities.”

In July, the OCC announced that it had in early June entered into its own separate enforcement action against Summit National Bank, a subsidiary of Mode Eleven.

The OCC’s order, similar to the Board order with Mode Eleven, says that Summit National Bank “engaged in a number of unsafe and unsound practices, including those related to BSA/AML, capital and strategic planning, liquidity risk management, transactions with affiliates, accounting, and violations of laws.”

Looking at the list of laws that the OCC’s order goes on to cite, two things stood out. First, the OCC cites to a violation of 31 CFR 1010.610, the provision of the Bank Secrecy Act regulations that requires banks and other financial institutions to undertake appropriate risk-based due diligence in connection with offering correspondent banking accounts to foreign financial institutions. Second, consistent with the reference in both the Board and OCC orders to affiliate transactions, the OCC cites to violations of both Sections 23A and 23B of the Federal Reserve Act, as implemented by Regulation W.⁹

1. The link in the text is to the ILST requirements for large U.S. bank holding companies. Similar requirements apply to large savings and loan holding companies and to foreign banks with sizable operations in the United States, with respect to those U.S. operations.

2. Credit for spotting this goes to an anonymous account on X who flagged it to Steven Kelly.

3. The letter itself does not use the term whole business securitization, but the OCC uses the term here in linking to the letter.

4. I first saw Director Chopra’s statement mentioned by the Wall Street Journal’s Andrew Ackerman on X.

5. Under the proposed policy statement, the FDIC would evaluate whether “a merger between IDIs will enable the resulting IDI to better meet the convenience and the needs of the community to be served than would occur absent the merger” (emphasis in original). The FDIC’s two dissenting board members questioned whether this was consistent with the statutory language which requires the FDIC to “take into consideration” the convenience and needs of the community to be served.

6. It is not necessarily obvious that capital requirements would apply to Jiko Group at the holding company level in the first place, given that under the Board’s Small Bank Holding Company Policy Statement a company with less than $3 billion in total consolidated assets that meets certain conditions is not subject to consolidated capital requirements at the holding company level. Jiko Group has only around $138 million in total consolidated assets, but presumably does not meet one or more of the other criteria necessary to be able to rely on the policy statement.

7. Jiko has only been required to file the Y-9C since 2023. The company’s initial Y-9C filings - for example, this one for the quarter ending June 30, 2023 - included a note saying “The Fed considers our preferred shares as a common shares when calculating the capital ratios.” This could be read to suggest the opposite to what the more recent note suggests, but because the numbers in the filing don’t show a significant amount of common equity my guess is that something just got confused in putting together the note.

8. Note, too, that at the bank level the leverage and risk-based capital ratios for Mid-Central National Bank (RSSD 773171) are all comfortably above regulatory minimums.

9. Specifically the order cites violations of 12 CFR 223.14(a) and 12 CFR 223.51.