93-7

November 10, 1993

Re: Metals Program and Hypothecation of Assets

Dear M ________:

This is in reply to your letter of July 15, 1993.

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 U.S. Treasury securities, as collateral in connection with the operation of the Bank’s Precious Metals Division. Bank plans to procure precious metals, such as gold and silver, from suppliers by lease or consignment. Bank proposes to pledge collateral to secure the Bank’s obligation to return the metals to the suppliers or to have its correspondent bank issue letters of credit for the benefit of the suppliers. Bank then proposes to lease or consign such metals to users such as jewelers or jewelry manufacturers secured by letters of credit or other collateral from the users.

The Bank will be obligated to return the metals to the suppliers or pay the current price for the metals. You also confirmed that in most cases, the precious metals will probably be purchased by the Bank. Your letter also indicates that the Bank plans to “hedge” these transactions to protect against price risk.

Your question is whether the Department objects to the proposed hypothecation by the Bank of its assets, such as U.S. Treasury securities, to secure Bank’s obligation to return precious metals to its suppliers or pay for the metals as described in your letter and in our discussions.

Based upon the information provided in your letter, it appears that the pledging is not prohibited per se under the Banking Law. However, pledging the Bank’s assets to secure its own obligation to return the precious metals to its suppliers or pay for the metals 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 pledging of the Bank’s securities to secure its obligations should be consistent with the Bank’s liquidity plan and its liquidity needs, and should not have an adverse impact on the Bank’s liquidity position. You represented in your letter that the hypothecation of any assets by the Bank would be maintained within the limits of Financial Code Section 1201 and Financial Code Section 1202 whether or not for financial accounting purposes they would be treated as liabilities for borrowed money on the Bank’s financial statements. Additionally, the aggregate amount of assets pledged to secure the Bank’s obligations to its suppliers under its precious metals program should not exceed 50 percent of the shareholder’s equity of the Bank.

We hope this responds to your inquiry. Your cooperation and courtesy are appreciated. Please contact us if you have any further questions.

Very truly yours,

JAMES E. GILLERAN
Superintendent of Banks

By

DIANA H. NISHIURA
Senior Counsel

DHN:la

cc: J. R. Paulus, San Francisco
P. Van Hoecke, San Francisco
J. F. Carrig, San Francisco
W. G. Thompson, San Francisco

——————————————————————————–

July 15, 1993

Mr. David Scott
Deputy Superintendent of Banks
California State Banking Department
300 South Spring Street, Suite 15513
Los Angeles, California 90013

RE: Pledging of Collateral

Dear David:

________ has encountered several situations where, in order to accommodate existing business or facilitate new transactions, it has been asked to pledge securities, such as treasury securities, as collateral for facilities from other financial institutions or similar parties. For example, in connection with the California Self-Insured Workers Compensation Program, Bank customers require letters of credit issued to the State of California to secure their obligations under the self-insured program. Under regulations adopted by the Department of Insurance (we understand based on suggestions from the State Banking Department) the issuer of the letter of credit is required to have a long term debt rating which neither ________ nor its parent, ________, have. As a result, in order to get letters of credit confirmed by correspondent banks to the level necessary for these self-insured programs, ________ has been requested to pledge collateral such as treasury securities The obligation of ________ customer is based an a credit evaluation of that customer and may include collateral, including business assets and/or marketable securities. Quite often the letter of credit is issued under an existing line of credit made available for that customer, blocking the line to the extent of the letter of credit. These transactions are priced based on the credit worthiness of the customer, the existence of collateral and, of course, the cost of the confirmation from the correspondent bank with that cost also being a factor of the credit of ________, which is significantly enhanced by the pledging of treasury securities, thereby reducing the overall cost of the transaction. In order for ________ to maintain the customer relationships, it has to be able to provide the letters of credit for the Workers Compensation Program.

Other situations have arisen, such as the operation of the Bank’s Precious Metals Division, where metals are procured from major dealers, both financial institutions and others, and, in turn, the metals are provided to users on consignment or lease basis secured by letters of credit or other collateral, which facilities require to procure the metal and, in order to induce the metals’ suppliers to provide leases or consignments to the level appropriate for the operations of the Precious Metals Division, it has been proposed that treasury securities be pledged for the obligation to return the metal. In order to deal with the price risk involved in acquiring metal with the obligation to return it in its specific quantity, the transactions are hedged by corresponding sale or purchase transactions on a futures basis to protect against the price risk inherent in commodities transactions.

Under California Financial Code Section 1200 et seq., a California state-chartered bank is authorized to hypothecate its assets as security for borrowed money as provided in the Section, subject to the margin requirements of Section 1201 and the absolute limits of borrowings under Section 1202. It is contemplated that the hypothecation of treasury securities for the letter of credit confirmations and metals transactions, as well as any other such transactions, would be maintained within the limitations of Sections 1201 and 1202, whether or not for financial accounting purposes they would be treated as liabilities for borrowed money on the Bank’s financial statements.

In light of the forgoing, ________ intends to proceed with the pledging of treasury or other securities for these and similar transactions unless notified by the State Banking Department of an objection. Your earliest response to this issue is requested. Thank you for your anticipated prompt review.

Very truly yours,

cc: Diana Nishiura