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Will the Federal Reserve Board Letter of Nov. 15, 2012 Impact BOLI Plan?

By: Glenn Blackwood, Equias Alliance | Spring, 2013

On November 15, 2012, the Board of Governors of the Federal Reserve System issued a letter (“SR 12-15”) to advise state member banks that, effective January 1, 2013, they may no longer rely solely on credit ratings issued by nationally recognized rating organizations to determine whether a particular investment is a permissible “investment security” for the bank.

The purpose of this communication is to provide Equias Alliance’s analysis of the new ruling and to assess its possible impact on your BOLI program. Briefly, our findings are that SR 12-15 does not mandate any new requirements for state member banks with BOLI plans that were not already in place under Office of the Comptroller of the Currency (“OCC “) Bulletin 2004-56. OCC Bulletin 2004-56 required banks to do an independent financial analysis of the creditworthiness of its BOLI carrier and investments. Further, the OCC had already issued guidelines for national banks on June 13, 2012 in the attachment to OCC Bulletin 2012-18 stating that national banks and Federal savings associations could no longer rely solely on credit ratings issued by nationally recognized rating agencies to determine whether a particular investment was a permissible security. The Federal Reserve Board is now simply issuing similar guidance for state member banks. No new ground has been broken.

Background

Section 939A of the Dodd-Frank Wall Street Reform and Consumer Act of 2010 requires that each federal agency remove any references in their regulations that banks can rely on external credit ratings to assess the creditworthiness of a security or money market instrument.

To comply with this requirement, on June 13, 2012, the OCC issued an attachment to Bulletin 2012-18 providing national banks and Federal savings associations with detailed guidance on how these banks could determine whether a security is “investment grade” and, thus, a permissible investment.

Briefly, the standard is that the security must have a low risk of default by the obligor, and the full and timely repayment of principal and interest must be expected over the anticipated life of the investment. Further, investment securities should have “good to very strong credit quality”.

The OCC also expects banks to conduct an appropriate level of due diligence to understand the inherent risks of the security. The due diligence process may include internal analysis, third-party research including external creditratings, internal risk ratings and other sources of information.

Analysis

To ensure compliance by state member banks with Section 939 of the Dodd-Frank Act, the Federal Reserve Board of Governors issued SR 12-15 on November 15, 2012. This letter stated that, effective January 1, 2013, state member banks may no longer rely solely on credit ratings issued by national rating agencies as to whether a particular security was a permissible investment security. The letter also incorporated within it the guidelines from OCC Bulletin 2012-18.

It is also important to note that OCC Bulletin 2004-56 issued several years ago providing guidance to banks on the purchase of Bank Owned Life Insurance (“BOLI”) stated that that “Before purchasing BOLI, an institution should conduct an independent financial analysis of the insurance company and continue to monitor its condition on an ongoing basis.” The guidelines from the OCC in 2004-56 never suggested it was acceptable for a bank to rely solely on national rating agencies for the determination of a carrier’s creditworthiness or the creditworthiness of individual investment securities.

Conclusion

The November 15, 2012 letter from the Federal Reserve Board does not create any additional responsibilities for a bank that were not already in effect as a result of OCC 2004-56 and OCC 2012-18. The thrust of these bulletins is that banks that purchase BOLI should be prepared to do an independent evaluation of the carrier(s) issuing the BOLI as well as the actual investment portfolios they are selecting to be sure the securities are investment grade. The banks can take into consideration external credit ratings, but not rely solely on them. The banks can also look to third parties for help in evaluating the carriers and portfolios. This analysis must be done not only at the time of purchase, but also on an ongoing basis.

If you have any questions or would like more information on this subject, please contact Glenn Blackwood at Equias Alliance, (561)798-5620 or gblackwood@equiasalliance.com.

Glenn Blackwood is a registered representative of, and securities are offered through, Pro-Equities, Inc., a Registered Broker/Dealer, and member FINRA and SIPC. Equias Alliance is independent of ProEquities, Inc.

Glenn Blackwood is a Managing Consultant with Equias Alliance. With more than 20 years of experience in the BOLI/nonqulified benefits industry, he has assisted hundreds of banks with the design and implementation of programs.

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