93-6

September 17, 1993

Re: Financial Code Section 1201 and 1202 — Hypothecation of Assets for
Letter of Credit Confirmations

Dear M ________:

This is in reply to your letter of July 15, 1993 (“Letter”).

As we understand the facts, based on your Letter and our telephone discussions of September 3, and September 7, 1993, ________ (“________”) has been asked to pledge assets, such as treasury securities, as collateral for facilities from financial institutions in connection with the California Self-Insured Workers’ Compensation Program.

As we understand it, ________ customers, who are primarily employers, will require standby letters of credit to be issued for the benefit of the State of California to secure their obligations under the state self-insured program (“Letters of Credit”). Department of Insurance regulations require the issuer of the Letters of Credit to have a long term debt rating which neither ________ nor ________ have. As a result, ________ is seeking to have its correspondent bank confirm ________ Letters of Credit to the level necessary for these self-insured programs. For this purpose, the ________ correspondent bank has asked the ________ to pledge collateral, such as treasury securities, to secure bank’s obligations under the request for confirmation of its Letters of Credit.

Your question is whether the Department objects to the proposed hypothecation by the ________ of its assets, such as treasury securities, to secure ________ obligation under its request for confirmation of its Letters of Credit (the “Pledge”).

Based upon the information provided in your Letter, it appears that the Pledge is not prohibited per se under the Banking Law. However, the Pledge must be subject to scrutiny under principles of safety and soundness.

Generally, whether an activity is considered safe and sound is determined in the context of all relevant circumstances on a case-by-case basis.

In particular, the Pledge should be consistent with the liquidity plan and its liquidity needs and should not have an adverse impact on the liquidity position. Also, absent extraordinary circumstances, the amount of the Pledge should not, together with a customer’s other outstanding obligations to the ________, as defined in Financial Code Section 1220, exceed the lending limits in Financial Code Section 1221. Finally, the aggregate amount of assets pledged to secure letters of credit should not exceed the shareholder’s equity of the ________.

For purposes of clarification in response to your earlier question, this is to confirm that in this letter, the term “customer’s other outstanding obligations to the ________ as defined in Financial Code Section 1220” does not include the amount of the Letters of Credit as may be required to be included in the state lending limits pursuant to federal regulations.

We will respond to your questions regarding the hypothecation of assets under its precious metal program in a separate letter.

Your cooperation and courtesy is appreciated. Please contact us if you have any questions.

Very truly yours,

JAMES E. GILLERAN
Superintendent of Banks

By

DIANA H. NISHIURA
Senior Counsel

DHN:la

cc: J. F. Carrig, San Francisco
W. G. Thompson, San Francisco
P. Van Hoecke, San Francisco
D. L. Scott, Los Angeles
B. F. Tom, Los Angeles