On February 4th, the Treasury Department issued new guidelines on executive pay and related matters applicable to financial institutions receiving government assistance. The guidance provides for a distinction between institutions participating in any “new generally available capital access programs” (e.g., programs similar to the existing CPP) and those institutions needing “exceptional assistance” (e.g., the specific negotiated agreements with AIG and BofA). Outside of the new CEO Certification requirement, the new guidelines did not apply to financial assistance arrangements already in place. The restrictions include limitations on compensation, expanded clawback restrictions, reduction of golden parachutes and approval of luxury expenditures. CEOs of each institution that has or will receive government assistance must certify each year that the institution has complied with all executive compensation restrictions. The American Recovery and Reinvestment Act (ARRA), also known as the “Stimulus Act”, was largely modeled after these guidelines.
On February 10th, newly appointed Treasury Secretary Geithner unveiled the administration’s new Financial Stability Plan. As part of this plan, Secretary Geithner announced the broad architecture of three new programs: (i) additional capital investments in banks, (ii) the creation of a Public-Private Investment Fund that would combine government capital and financing and private capital to purchase “legacy” loans and assets from banks, and (iii) an expansion to $1 trillion and coverage of additional asset classes for the previously announced Term Asset-Backed Securities Loan Facility (TALF).
On February 25, 2009 the OCC Released NR 2009-14, announcing that federal bank regulatory agencies will be conducting forward-looking economic assessments of large U.S. banking organizations (bank holding companies exceeding $100 billion of assets) in connection with the Capital Assistance Program (CAP). These interagency assessments are intended to test the capital adequacy of these institutions under two adverse scenarios; each reflecting a deeper and longer recession than consensus baseline forecasts. The assessment process may impact which organizations will be allocated capital under CAP and how it will be deployed. The assessments are to be completed no later than April 30, 2009. Additional information is available in a Frequently Asked Questions (FAQ) PDF document included with the release.
On January 30, FASB posted FASB Staff Position (FSP) FAS 107-b and APB 28-a (Interim Disclosures about Fair Value of Financial Instruments). If adopted as proposed, FASB Statement No. 107 will require institutions to disclose the fair value of its financial instruments in its interim financial statements beginning with reporting periods after March 15, 2009 (presently, FAS 107 only requires disclosure of fair values in annual financial statements). Accordingly, if adopted, APB 28, Interim Financial Reporting, will be amended to reference FAS 107. FASB is soliciting comments through March 2, 2009.
Last month, House bill H.R. 607 was introduced. If enacted, this bill would require the SEC to issue guidance on the interpretation of the fair value accounting standards set forth by FASB, including the SEC’s interpretation and application of FASB Statement Number 157. The guidance would address the issues and recommendations the SEC identified in its report submitted to Congress pursuant to EESA.
In response to recommendations within the SEC’s study on mark-to-market accounting, FASB announced agenda projects to improve determining and disclosing fair value estimates. The individuals involved in the new FASB fair value accounting application project will look at the procedures for determining when a market for an asset or liability is active/inactive, determining when a transaction is distressed, and applying fair value to interests in alternative investments, such as hedge funds and private equity funds. FASB hopes to complete the application guidance project by June 30, 2009.
The Trustees of the International Accounting Standards Committee, the oversight body of the International Accounting Standards Board (IASB), announced the creation of a new monitoring board that will oversee the trustees. The monitoring board is intended to ease interaction between national and international governmental regulators. The monitoring board will include representatives from the SEC as well as other stakeholders interested in the needs of investors.
The SEC issued final rules requiring companies to provide financial statement information in a form that is intended to improve usefulness to investors and assist in automating regulatory filings. The rules will apply to public companies and foreign private issuers that prepare their financial statements in accordance with U.S. GAAP and foreign private issuers that use International Financial Reporting Standards issued by the IASB. Companies will provide their financial statements to the SEC and on their corporate websites using eXtensible Business Reporting Language. The effective date is April 13, 2009.
This month the much talked about ‘stimulus bill’ was enacted. ARRA is voluminous and we have not completely digested it, but there were a few areas we wanted to note as of this writing.
First, Section 1261 of the Act repeals IRS Notice 2008-83. That Notice provided relief for banks from IRC § 382(m) for losses and deductions incurred following an ownership change. Congress determined that the Treasury Secretary did not have authority to provide exemptions or special rules that apply only to particular industries or classes of taxpayers. However, noting the importance of taxpayers’ ability to rely on guidance issued by the IRS, the Act gives the Notice full force and effect with respect to any ownership change or written binding contracts for ownership change that occurred on or before January 16, 2009. Section 1262 of the Act adds a new Section 382(n) to the IRC adding special rules for the treatment of certain ownership changes for purposes of limitations on net operating loss carry forwards and certain built-in losses.
Second, ARRA also provides a federal subsidy for COBRA premiums on behalf of eligible employees and covered family members with adjusted gross incomes below a maximum threshold who lost or will lose coverage due to involuntary termination of employment from September 1, 2008 though the end of 2009. The Act provides a subsidy of 65 percent of the COBRA continuation coverage premiums for eligible individuals for a maximum of 9 months. The federal assistance provisions impose new election notice requirements upon sponsors of single-employer group health plans, multiemployer plans and group health insurers with penalties for failure to comply.
Lastly, the Act modifies the executive compensation restrictions that apply to financial institutions participating in the TARP. The Act contains limits on the incentive compensation and severance that may be paid to executives at TARP recipients and the amounts that TARP recipients may deduct related to executive pay. The Act’s restrictions will apply to all past and future TARP recipients. These restrictions are in addition to the new TARP executive compensation restrictions announced by the Treasury Department referenced above. There is considerable concern that future legislation may seek to apply some of these restrictions beyond the scope of companies accepting TARP funds.
Introduced January 29th, the 2009 bill takes a different approach to the regulation of hedge funds by proposing amendments to the Investment Company Act of 1940. These amendments would require private investment funds (including hedge funds, venture capital funds and private equity funds) with $50 million or more under management to register with the SEC. The 2009 bill also would require such funds to submit an annual information statement to the SEC and adopt anti-money laundering programs.
Two House members, Melissa Bean (D-IL) and Ed Royce (R-CA), announced that they plan to introduce the National Insurance Consumer Protection and Regulatory Modernization Act. The Act would create a federal charter for insurance regulation that would incorporate support for all National Association of Insurance Commissioners model laws. The bill would create a national insurance regulator who would work with a pan-industry systemic risk regulator to better regulate the financial system. The new bill will stipulate that the proposed Office of National Insurance has the authority to access the financial records of all affiliates within the holding company structure. Further, the legislation will require federally registered insurance holding companies that have a predominate share of insurance businesses to be regulated at the holding company level. In light of market turmoil and the difficulty some insurers are experiencing, there is growing sentiment for advancing an optional federal charter/regulation. Some have recently argued that systemic financial market risk cannot be adequately monitored and mitigated unless such efforts are inclusive of the insurance industry. States, of course, remain resistant to these proposals.
On February 23rd, McClanahan Myers Espey, LLP (Houston, Texas) filed a lawsuit on behalf of Irma Johnson against Amegy Bank, N.A. (Texas). In this case, the plaintiff acknowledges that written consent was obtained; however, the plaintiff alleges that the bank (then Southwest Bank of Texas) fraudulently induced the plaintiff’s late husband to get his consent and that he did not have the mental capacity to give valid consent. Ms. Johnson allegedly learned of the policy when she erroneously received the death benefit check made payable to Amegy Bank. While the facts of this matter appear to be highly unusual (and Amegy Bank has not yet filed a response), we thought it was noteworthy in light of the recent announcement released by The Clearman Law Firm in which they are seeking to bring a class action lawsuit against banks who own “secret” life insurance on employees (named members of both law firms have had past affiliations with one another).
McClanahan Myers Espsy, LLP is litigating a matter on behalf of plaintiffs against Hartford in Oklahoma federal court. The Havenstrite plaintiffs claim that Hartford unlawfully misappropriated their personal information (specifically, their names, dates of birth, sex and Social Security Numbers) to issue “secret” COLI policies for its own commercial use and benefit. On December 31, 2008, Hartford’s motion to dismiss was denied. Hartford had previously been granted a dismissal in Texas federal court in which asserted similar misappropriation of personal information claims. The dismissal was affirmed in the federal appellate court (see Meadows v. Hartford Life Insurance Company, 492 F.3d 634 (5th Cir. 2007)) . We will continue to monitor developments of the Havenstrite case.
On January 22, 2009, Fifth Third Bancorp released its fourth quarter 2008 earnings and held their quarterly investor conference call. Included in the results was a non-cash estimated charge of $34 million to reduce the carrying value of one of the bank’s BOLI policies.
Since the fourth quarter of 2007, Fifth Third has recorded $392 million in BOLI write-downs. These BOLI policies are the subject of the pending lawsuit filed against the insurer (Transamerica Life) and the broker (Clark Consulting) on April 17, 2008. Both the insurer and the broker are wholly-owned subsidiaries of AEGON.
The remaining carrying value of the policies that have incurred the write-downs is $290 million. According to statements made in the quarterly investor conference call, all but $30 million is currently invested in cash equivalents or money market funds.
Prior disclosures by Fifth Third, as well as details contained in the above mentioned law suit, suggests that BOLI related write-downs have primarily stemmed from losses suffered on an unusually large allocation to a highly leveraged, fixed income hedge fund (i.e., with losses substantially in excess of the stable value agreement’s permitted MV/BV ratio thresholds).
The table below chronicles Fifth Third’s announcements regarding charges to its BOLI holdings.
|Newly Announced BOLI Charge (Millions)
|Adj. to Prior BOLI Charge (Millions)
|Cumulative BOLI Charges (Millions)
|Remaining BOLI Policy Value (Millions)
|SEC 8-K (Est.)
|Earnings Release (Est.)
|Earnings Release (Est.)
|Earnings Release (Est.)
|Earnings Call and SEC 10-Q
|Earnings Release (Est.)
On February 26, 2009, Royal Bank of Canada (RBC) released their first quarter results (note that RBC uses a fiscal year end of 10/31). RBC provided more detailed information relating to its exposure arising from BOLI stable value contracts in the Management’s Discussion & Analysis section of the quarterly report to shareholders (see pages 7-8 of the report).
As of 1/31/2009, the difference between the notional value and fair value of RBC’s BOLI contracts was C$2,552 million (~$2,049M US). This represents the loss that would be recognized if all insurance contracts were surrendered on that date.
The exposure has ballooned significantly since RBC’s Q4 2007 results; the difference between notional and fair value as of 10/31/2007 was reported at C$433 million (~$348M US). RBC recognized write-downs of C$162 million (~$130M US) during 2008 and C$26 million (~$21M US) in the first quarter of 2009. These write-downs reflect both the value of the assets underlying the investment portfolios of the policies and RBC’s estimated probability of policyholders’ surrenders.
RBC also disclosed the composition of its exposures and broke them down between leveraged and non-leveraged investment divisions (see below table).
The C$1,578 million (~$1,267M US) exposure to leveraged assets relates to a single contract. RBC estimates that its payment obligation if this contract were surrendered on 1/31/2009 would be approximately C$500 million (~$400M US) after taking into account contractual protections.
Finally, RBC noted that one BOLI policy was surrendered during the quarter. It was settled at market value (i.e., RBC did not have a payment obligation).
In the aftermath of the NAIC’s late January rejection of the ACLI’s capital relief proposals for life insurers, a number of state insurance regulators have permitted variations from the usual statutory filing regulatory requirements in order to ease the capital requirements of insurers’ 2008 financial statements. Hartford Financial Services Group reported in its 10-K that it received approval from the Connecticut Insurance Department regarding the use of two permitted practices in the statutory financial statements of its life insurance entities. These permitted practices led to an increase in its statutory surplus for the life operation of $987 million as of December 31, 2008. Indiana, Iowa and Ohio have also recently granted capital relief to life insurance carriers. Carriers domiciled in these states (and therefore, impacted by the relief) include Lincoln National Life Insurance Company, Transamerica Life Insurance Company, Midland National Life Insurance Company, Nationwide Insurance Company and Principal Life Insurance Company.
The New York State Insurance Department has announced, through the publication of Circular Letter Number 4, that when insurers file financial statements, they must exclude the impact of any capital and surplus exceptions granted by other states.
The SEC adopted rule amendments that impose additional requirements on nationally recognized statistical rating organizations (NRSROs) in order to address concerns about the integrity of their credit rating procedures and methodologies. In summary, the rule amendments require an NRSRO to provide enhanced disclosure of procedures and methods used in determining credit ratings, expand the records that NRSROs must maintain and make available for SEC inspection, and require an NRSRO to publicly disclose a random sample of 10% of certain credit ratings. In addition to issuing the final rules, the SEC also proposed additional rules for comment.