Municipal Revenue Bond Underwriting by Banks and Trust Companies
January 20, 2004
TO THE CHIEF EXECUTIVE OFFICER OF THE INSTITUTION ADDRESSED:
This letter addresses the authority of New York State-chartered banks and trust companies (hereinafter “banks”) to underwrite municipal revenue bonds under current New York Banking Law.
Municipal revenue bonds are debt obligations of a city, state or municipal authority issued for a public purpose. In most cases, interest from the bonds is exempt from federal and state income taxes. The significant difference between municipal revenue bonds and general obligation bonds is that general obligation bonds are backed by the “full faith and credit” and taxing authority of the issuer. In contrast, municipal revenue bonds are repaid from the revenue of the project financed by the bonds, such as a hospital or housing project. Underwriting refers to the process whereby securities are distributed from an issuer to the public market by an underwriter who agrees with the issuer to distribute the securities. In a typical underwriting, the underwriter advises the issuer concerning the terms, amount and timing of the securities to be issued.
Authority to Underwrite and Invest in Government Obligations under New York Banking Law
The New York Banking Law does not directly address the authority of a New York bank to underwrite debt securities. However, Banking Law Section 97 permits New York banks, subject to any restrictions or limitations in the Banking Law, to invest in bonds, notes, debentures and other obligations which are not in default as to either principal or interest when acquired. This authority to invest in debt obligations includes obligations of both public and private issuers.
Limitations on the exposure of a New York bank to any one obligor are set forth in Banking Law Section 103. That section generally prohibits a bank from extending unsecured credit to any person (which term includes an individual, partnership, unincorporated association, corporation or body politic) in an amount which will exceed 15% of the capital stock, surplus fund and undivided profits (“capital”) of the bank or trust company. Banking Law Section 103 allows extensions of credit up to 25% of a bank’s capital to any one person, provided the amount above 15% is secured, or is extended upon bills of exchange or bankers’ acceptances that meet certain conditions.
Several exceptions exist to the above-noted lending limitations. Among the loans to which the limitations do not apply are: (1) any loan guaranteed as to principal and interest by the United States, or New York State, or any city, county, town, village or school district in New York State, as well as certain federal or state agencies or departments enumerated in the Banking Law or designated by the Banking Board; and (2) any loan fully-secured by direct obligations of the United States, New York State, or any city, county, town, village or school district in New York State, or any department, agency or instrumentality of the United States or New York State.
Accordingly, based on Sections 97 and 103 together, the Department in the past has interpreted the Banking Law as permitting New York banks to underwrite without limitation obligations backed as to principal and interest by the full faith and credit of the United States government, or the New York State government, or that of any political subdivision thereof. The backing by the full faith and credit is understood to mean that the full taxing power, as opposed to the revenues from a specific project, is behind the government guarantee. The Department’s interpretation is based on the reasoning that an investment in bonds under Section 97 may also be viewed as a loan or extension of credit to the issuer. Since Section 97 permits a New York bank to invest in government obligations (as long as they are not in default) and Section 103 places no limitation on extensions of credit to U.S. or New York governmental subdivisions that place their full faith and credit behind the loan, or on loans that are fully-secured by such obligations of the U.S. or New York State government, it follows that a New York bank may invest in, deal in or underwrite government obligations without limitation, except for safety and soundness limitations.
On the contrary, for municipal revenue bonds, which are backed by narrower revenue streams than general taxes, the limitations on extensions of credit to one borrower in Section 103 would apply. A 25% of capital limit applies to certain types of municipal obligors:
“loans [exclusive of those described in Section 103(1)(a) for which there is no lending limit] to any state other than the state of New York, or to any foreign nation, the New York State thruway authority, the Triborough bridge and tunnel authority, the Port Authority of New York Authority, a railroad corporation, a municipal corporation of this state, a corporation subject to the jurisdiction of a public service commission of this state, or any international lending facility or public benefit corporation designated by the banking board by general or specific regulation upon a three-fifths vote of all its members, may equal but not exceed twenty-five per centum of the capital stock, surplus fund and undivided profits of such bank or trust company.”(Section 103(1)(c)).
Loans to municipal issuers that do not fall within Section 103(1)(a) or 103(1)(c) would be subject to the general limitation in Section 103 – unsecured loans to one person or entity up to 15% of the bank’s capital plus an additional 10% secured. Based on the rationale that both a loan to or investment in debt obligations of an issuer produce similar economic results, this loan limitation under New York Banking Law would also therefore be applicable in the case of a New York bank investing in, or underwriting, municipal revenue bonds. In other words, for certain municipal issuers enumerated in Section 103(1)(c), a bank could underwrite bonds up to 25% of capital, while for all other municipal issuers, the limit would be 15% of capital. It should be noted that, given that this interpretation bases such underwriting authority on the legal lending limit, the aggregate investment, underwriting and unsecured loan exposure may not exceed the applicable unsecured lending limit (i.e. 15% or 25%, depending on the issuer). A bank engaged in municipal revenue bond underwriting should expect that such activities and compliance with applicable limitations would be subject to review as part of the Department’s safety and soundness examination of the institution.
Additional Federal Law Limitations on New York Banks Underwriting or Investing in Government Obligations
In addition to New York Banking Law provisions applicable to investing in or underwriting municipal revenue bonds, laws and regulations applicable to national banks conducting these activities must also be considered since, pursuant to Section 24 of the Federal Deposit Insurance Act (“FDI Act”), state insured banks are generally limited in their investments and activities conducted as principal to those investments and activities in which national banks may engage in as principal.
In addition, Federal Reserve Board (“FRB”) and Federal Deposit Insurance Corporation (“FDIC”) regulations also determine the permissible activities of state insured member banks, and non-member banks, respectively. Pursuant to Section 9(20) of the Federal Reserve Act, state member banks are subject to the same conditions and limitations with respect to the purchasing, selling, underwriting and holding of investment securities and stock as are applicable in the case of national banks. In the case of state non-member banks however, pursuant to Section 24 of the FDI Act, an insured bank may apply to the FDIC to conduct activities as principal that are not authorized for national banks, provided of course that the activities are authorized for the state bank under state law. The FDIC may permit a state insured bank to engage in such activities if the FDIC finds that the activities would pose no significant risk to the appropriate deposit insurance fund and the state bank is and continues to be in compliance with applicable capital standards prescribed by the appropriate federal banking agency. (12 U.S.C. 1831a(a)).
National Bank Investment and Underwriting Limitations
Pursuant to the National Bank Act (12 U.S.C. 24 (Seventh)) and the OCC’s investment regulations in 12 C.F.R. Part 1 (“Part 1”), national banks have long been permitted to underwrite, deal in and invest in, without limitation as to capital, general obligations of the United States, or of any state, as well as in several types of specifically enumerated government and agency-backed obligations (so-called Type I securities under Part 1).
Type II securities under the OCC’s Part 1 include, among certain others, “obligations issued by a state, or a political subdivision or agency of a state, for housing, university or dormitory purposes that would not satisfy the definition of Type I securities”. Leaving aside the authority to underwrite municipal revenue bonds recently granted to national banks under the Gramm-Leach-Bliley Act of 1999 (“GLB”), described below, Part 1 provides that a national bank may deal in, underwrite, purchase and sell Type II securities for its own account, provided that the aggregate par value of Type II securities issued by any one obligor held by the bank does not exceed 10% of the bank’s capital and surplus (hereinafter, “capital”).
Type III securities under Part 1 means investment securities that do not qualify as Type I, II, IV, or V (Types IV and V securities include investment grade small-business-related and mortgage-related securities, among others). Type III securities include corporate and municipal bonds that do not fall within the Type I or Type II definitions. Again leaving aside the GLB municipal bond underwriting authority, under Part 1 national banks may not underwrite, but may purchase and sell Type III securities for their own account provided that the aggregate par value of Type III securities issued by any one obligor held by the bank does not exceed 10% of the bank’s capital. Among Type III securities would therefore be included most types of municipal revenue bonds other than the housing, university or dormitory obligations that constitute Type II securities.
Accordingly, these various restrictions on a national bank’s authority to underwrite or invest in various Type I, II and III municipal securities as set forth in the OCC’s Part 1 place limitations on the underwriting and investment by New York state insured banks in municipal obligations in addition to applicable limitations on these activities imposed by the New York Banking Law.
Prior to GLB, a national bank’s ability to underwrite municipal obligations was unlimited as to general obligation municipal obligations and limited as to Type II and Type III securities as provided in Part 1 of the OCC’s regulations discussed above. GLB amended the National Bank Act to permit national banks that are well-capitalized to underwrite and invest in certain municipal revenue bonds, without limitation as to capital. Specifically, well-capitalized banks may underwrite and invest in:
“obligations (including limited obligation bonds, revenue bonds and obligations that satisfy the requirements of Section 142(b)(1) of the Internal Revenue Code of 1986) issued by or on behalf of any State or political subdivision of a State, including any municipal corporate instrumentality or authority of any State or political subdivision of a State.” (12 U.S.C. 24 (Seventh)).
In other words, for well-capitalized national banks, such municipal revenue obligations are considered Type I securities. For non-well-capitalized national banks, the ability to underwrite and invest in Type II and Type III securities is limited to pre-GLB levels discussed above, even though such Type II and Type III securities might qualify as Type I securities for a well-capitalized bank.
Under New York Banking Law, the Department interprets the Banking Law to permit New York state-chartered banks to underwrite and invest in municipal revenue bonds subject to New York Banking Law lending limits in Section 103. A bank’s investment, underwriting and loan exposure must be aggregated for these purposes. Since the limitations in the OCC’s Part 1 also must be followed by New York state insured banks, in most cases New York banks may only underwrite and invest in municipal revenue bonds to the extent permitted in the OCC’s Part 1. As noted above, well-capitalized national banks may now invest in and underwrite municipal revenue bonds as defined in GLB without limitation as to capital. Therefore, for well-capitalized banks, the OCC’s Part 1 regulations are less restrictive than New York law with respect to municipal bond underwriting authority. The OCC’s Part 1 regulations appear to be more restrictive than New York law, however, for non-well-capitalized banks. A non-member insured New York state bank may, however, make application to the FDIC pursuant to Section 24 of the FDI Act to exceed the powers of national banks if New York state law would authorize broader powers.
Pending a legislative amendment or an amendment to the Banking Board’s regulations pursuant to New York’s wild card statute to authorize New York banks to underwrite municipal revenue bonds to the full extent permitted for national banks, the current municipal bond underwriting authority remains as described in this letter.
Any questions concerning the foregoing may be directed to Deputy Superintendent and Counsel Sara Kelsey or Assistant Counsel Rosanne Notaro in the Legal Division at (212) 709-1663.
Very truly yours,
Diana L. Taylor
Superintendent of Banks
 Section 142(b)(1) of the Internal Revenue Code enumerates certain “exempt facility bonds” that fall within that section.