bank dispute concerning required

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JUSt 1 0 1975

Issue Paper

Subject: SEC/Bank Dispute C o n c e r n i n g Required D i s c l o s u r e in Bank Holding Company Registration Statements Issue: Should bank holding companies, in connection w i t h the registration of securities for public sale, be. required to disclose internal information relating to the loan p o r t f o l i o s of their constituent banks? • Discussion: bank holding they disclose Specifically, areas:

Since March the SEC has been refusing to allow companies to m a r k e t their securities unless certain information concerning loan portfolios. the SEC is requiring disclosure in the following

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i. Non-Accrual Loans (listing of amounts of loans on which, for internal a c c o u n t i n g purposes, income is b o o k e d on a cash basis rather than a u t o m a t i c a l l y accrued pursuant to the t e r m s = o f the:loan instrument) ""

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2. Internal Loan C l a s s i f i c a t i o n s (listing of amounts of 1Sans wh'ic~ are r ~ g u l a r l y "watched" by bank management). 3. Loan Concentration by Industry as a P e r c e n t a g e of Capital (e.g., loans to all auto companies equal 22% of capital; loans to all oil companies equal 18~ of capital, etc.). The SEC contends that such i n f o r m a t i o n is "material" the meaning of the Securities Act of 1933) because:

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,i. Investors are g e n e r a l l y w o r r i e d about the condition of banks and are e n t i t l e d to information revealing alleged weaknesses; 2. Investors are entitled to have the "raw': financial data to enable them to make p r e d i c t i o n s as to t h e current and future earnings prospects of banks; and 3. ~nvestors are entitled to similar data c o n c e r n i n g all bank holding companies to enable them to make comparative evaluations for investment purposes. J

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Opposing Position. The SEC is being o p p o s e d by both the bank regulatory agencles and the bank holding c o m p a n i e s (with Citicorp -- parent of First National City Bank -taking the lead). One objection advanced by the C o m p t r o l l e r •is procedural: the SEC position represents a radical d e p a r t u r e from previous practice and therefore should be subject to public scrutiny via the normal a d m i n i s t r a t i v e r u l e m a k i n g process. With respect to substance, Citicorp has taken the lead, but the bank regulatory agencies have e x p r e s s e d informal concurrence with Citicorp's arguments. In a c o m p r e h e n s i v e m e m o r a n d u m filed with the SEC May 6, Citicorp contends that the required disclosures would be extremely misleading, creating unwarranted public doubts about the v i a b i l i t y of the Company in question, the banking system and the i n d u s t r i e s to which banks lend money, W i t h respect to non-accrual loans and internal classificatfons, Citicorp shows that there is no m e a n i n g f u l correlation between such status and ultimate c o l l e c t i b i l i t y and only sligh~ correlation between such status and profitability, even for the current year. Moreover, to the e x t e n t d i s c l o s u r e of such internal classification w o u l d reflect a d v e r s e l y on market price, it penalizes the well-run, c o n s e r v a t i v e l y managed institution which handles its loan p o r t f o l i o w i t h extra caution. They challenge the industry c o n c e n t r a t i o n request on relevancy grounds: like most big banks, C i t i c o r p has loans exceeding 10% of its capital to over 30 industry sectors and the data is therefore meaningless. Finally, they note that there is virtually no legal p r e c e d e n t for requiring information on the grounds that disclosure is n e c e s s a r y to dispel adverse rumors or to provide a basis for comparison. Impact on Bank Capital Raising. Since the SEC began taking this position (about mid-March), no m a j o r bank has come to the market. A large Chemical Bank issue was a b o r t e d after the required information was disclosed. Last week, after lengthy negotiations, M a n u f a c t u r e r s Ilanover issued a prospectus containing the required disclosure and prepared to come to market. On the eve of the offering, the issue was withdrawn. "Market conditions" were blamed, b u t ~ o t h e r comparably rated issuers came to m a r k e t the same week. Only

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a few small companies and Southeast Banking (the largest Florida holding company) have complied and been permitted to sell securities. Moreover, recently the SEC rejected the 10-K filing (annual report required of all public companies) of a Virginia bank holding company on the ground that it lacked non-accrual loan data • If this policy is pursued, it could close the secondary market for any holding company which does not compl~ since securities generally cannot be traded unless a current 10-K is on file. Status: N e g o t i a t i o n s have proceeded on three fronts: SEC/Citicorp; SEC/Bank Agencies/Treasury at Senior levels; SEC/Bank Agencies at Staff level. Since the SEC rejected Citicorp's arguments and directed it to supply SEC staff with the requested information, there has been no further S E C / C i t i c o r p contact. At the staff level, an SEC/Bank Agency task force has been t a k i n g up a variety of issue~ relating to regulation of bank securities, and the question is being considered in this context. At the Senior level, Treasury has made two proposals to Chairman Garrett and to the bank agencies: i. That in lieu of such disclosures, the relevant bank agency provide a certification as to the soundness of a bank's loan portfolio. Both the bank agencies (which are concerned about liability -in the event a favorable certification proves incorrect) and the SEC are considering this proposal. 2. To break the SEC/Citicorp impasse, that Citicorp provide the requested factual information to the Comptroller, which in turn would provide it to the SEC staff. This would meet the SEC's argument that it cannot decide on Citicorp's arguments without the underlying factual material as to actual loan experience. This procedure would allow Citicorp to save face, since it has previously expressed that fear that if it provided such information directly to the SEC, it might ultimately become part of the public record. Citicorp and the Comptroller have agreed, the SEC is still considering it.

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Evaluation. The Comptroller's procedural concerns are soundly based: the SEC clearly has departed from past practices and, in addition, is treating bank holding • companies differently than other issuers. W h a t the SEC is in effect asking for is management's internal p r e d i c t i o n s as to the future p r o f i t a b i l i t y of its investments. An a n a l o g y would be a requirement that Gillette d i s c l o s e its internal calculations as t o the e x p e c t e d pay out cycle of a new deodorant which is not selling well. D i s c l o s u r e s of that nature have never been required. In the final analysis, the SEC staff's p r o b l e m appears £o be conceptual: they do not seem to u n d e r s t a n d that for a bank, money is an earning a s s e t analogous to a new plant or a machine. Accordingly, they v i e w a $2~0 Million loan in technical default (i.e., debt service not current) not as a "capital" investment which m u s t be evaluated according to overall return prospects, but as a direct threat to the b o t t o m line. To treat such loans in that way -- i.e., requiring specif$c d i s c l o s u K e to the investor whic--h--at least implies some m a t e r i a l risk of immediate loss is m i s l e a d i n g and can u,td~zmine =~ zin the major banks and thus the banking system.

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