On July 7, 2021, Georgia Department of Banking and Finance, or DBF, published amendments to the Rules of the DBF, which are referred to as the "final rules." Pursuant to O.C.G.A. § 50-13-6, the final rules are effective on July 27, 2021. Among the updates within the final rules is an important addition to how investments in subordinated debt issued by banking organizations can qualify as permissible investments for state banks.
Subordinated Debt Securities
In light of the recent surge in purchases by Georgia
state banks of subordinated debt securities issued by banking organizations,
the DBF added a rule related to the permissibility of such investments by state
banks. The new rule is found at Rule
80-1-4-.01(8) and provides a non-exclusive method for determining the
permissibility of such investments.
The final rules provide a roadmap for state banks to confirm permissibility of such investments. Previously, state banks could invest in such securities under the same rule, but some institutions found a lack of clarity in determining whether the investments are permissible. The new rule can serve as the basis for a checklist for evaluating the purchase of such debt securities.
To determine permissibility, the purchasing bank should first determine that the securities are intended to qualify as Tier 2 capital for the issuer and contain terms that support such qualification. Typically, the marketing materials related to the issuance will state such intent, but the purchasing bank should ensure that the underlying legal documents conform to such requirements. Second, the purchasing bank should determine that the amount of its investment will meet applicable requirements. In order to satisfy the requirements of the rule, the bank's investment in each corporate issuer of Tier 2 subordinated debt securities must not exceed 15% of the bank's statutory capital base. Similarly, the bank's aggregate investment in Tier 2 subordinated debt securities must not exceed the bank's policy limits or 100% of the bank's statutory capital base, whichever is less. The subordinated debt securities must also be of investment quality, meaning that a rating in one of the four highest categories has been assigned to the securities by a nationally recognized rating service.
If the issuance of the Tier 2 subordinated debt securities is not registered under the Securities Act of 1933, or the Securities Act, it must be either eligible for resale pursuant to Securities and Exchange Commission Rule 144A or must be able to be sold with reasonable promptness at a price which corresponds to their fair value. Alternatively, the issuance of Tier 2 subordinated debt securities can satisfy the suitability analysis test described below. This flexibility allows securities sold pursuant to the general private placement exemption under Regulation D promulgated under the Securities Act to be purchased by state banks.
Before purchasing any Tier 2 subordinated debt securities, the investing bank must perform a due diligence suitability analysis. The purpose of the analysis is to determine whether the Tier 2 subordinated debt securities are suitable investments relative to the bank's tolerance for credit risk, asset liability position, sensitivity to market risk, and its liquidity exposure. The analysis should include, at minimum, the following:
- A complete credit analysis sufficient to determine that the issuer is creditworthy and has the ability to meet the repayment schedule. This should include a pro forma cash flow analysis.
The purchasing bank should maintain documentation of the suitability analysis in its files and should update the suitability analysis periodically, at least as frequently as annually during the term of the investment. Generally speaking, the marketing materials for the issuance should provide the information needed for the purchasing bank to complete its suitability analysis; however, purchasing banks should also ensure that they have ongoing information rights that allow them to keep the suitability analysis updated.
Finally, banks seeking to invest in Tier 2 subordinated debt securities should ensure that their written policies and procedures adequately address the risks inherent in these securities, including credit risk, market risk, interest rate risk, and liquidity risk.
The final rule's approach to permissibility for investments in Tier 2 subordinated debt securities is not exclusive, menaing that purchasing banks may also invest in the securities under the corproate debt securities provision contained in paragraph 1(d) of the same DBF rule or under the "all other securities" provision in paragraph (9) in instances where the investment meets the requirements of those paragraphs. However, the new provision should provide banks with additional comfort in purchasing such securities.
The other changes set forth in the final rule are largely technical in nature. Such changes include the following.
- Clarification that banks are to use average assets in preparing certain calculations of their dividend amounts that do not require prior approval from the DBF.
- Clarification of timing requirements of certain public notices.
- Clarification that notifications related to representative offices apply to bank holding companies and their subsidiaries as well as banks.
The DBF continues its practice of attempting to modernize its rules to reflect current practices. These rule updates are generally helpful to banks but require annual attention to the DBF's rulemaking in order to take advantage of the additional flexibility.