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Letter 48: Pledging of Bank Assets

The Division of Banking has received inquiries if it is permissible for state banks to enter into interest rate swaps and other derivative agreements (called "credit support agreements" in this letter) and to pledge bank assets to secure bank obligations under those credit support agreements. The purpose for credit support agreements in part is to hedge against the risk of loss due to interest rate fluctuations inherent in the bank's own loan operations. These credit support agreements are not entered into for investment purposes. It is recognized in the industry that the interest rate risks of fixed-rate loans can be neutralized by hedging those risks with appropriate interest rate swap agreements.

Additionally, in connection with certain credit support agreements a state bank may be required to pledge bank assets as collateral to the counterparty to the credit support agreement when changes in the interest rate environment cause the mark to market valuation of interest rate swap(s) to exceed a predetermined threshold level. The obligation to pledge bank assets is temporary in nature because of the frequent determinations of the value of the interest rate swap(s) and the frequent changes in the interest rate environment. As a result, a state bank may be in a position where it is borrowing on a temporary basis from the counterparty to maintain the agreed upon margin and may be required to secure that temporary borrowing with assets of the state bank if the margin exceeds the predetermined threshold level.

The authority of a state bank to incur obligations for borrowed funds and to pledge assets to secure those obligations is provided for in Section 221.0324, Wisconsin Statutes. This section defines the purposes for which a state bank may incur obligations for borrowed funds and pledge assets to secure those obligations. Under Section 221.0324, Wisconsin Statutes, a state bank may borrow money for temporary purposes, and may pledge assets of the state bank not exceeding 50% in excess of the amount borrowed as collateral security for that borrowing provided the board of directors of the state bank has adopted the appropriate resolution required under this section.

Therefore, under the provisions of Section 221.0324, Wisconsin Statutes, a state bank may enter into credit support agreements as described in this letter and may pledge bank assets to secure its obligations under those credit support agreements.

Bkg. Ltr. #48, November 23, 2009, Michael J. Mach, Administrator