Alert July 14, 2009

Federal Banking Agencies Issue Guidance Stating that Financial Institutions Should Use 20 Percent Risk Weighting for Warrants Issued by California

The FRB, FDIC, OCC, OTS and NCUA (the “Agencies”) jointly issued guidance (the “Guidance”) to financial institutions (“FIs”) concerning the appropriate treatment of registered warrants (the “Warrants”) issued by the State of California.  California, which is experiencing financial difficulties and has not yet adopted a budget, is issuing Warrants to pay for certain obligations.  California has, for example, issued Warrants to pay individuals for income tax refunds, local governments for social services and vendors for goods and services.  The Attorney General of California has opined that the Warrants are valid and binding obligations of California. 

The Agencies state in the Guidance that since general obligation claims on a state receive a 20 percent risk weight for regulatory capital purposes, the Warrants will also receive a 20 percent risk weight.  Moreover, the Guidance cautions that FIs must understand, manage and control the risks related to accepting and holding the Warrants, and “risk management practices should include evaluating the credit quality of the Warrants, establishing appropriate concentration limits and ensuring appropriate liquidity risk management.” 

Separately, the SEC issued a release stating that the Warrants are “securities” for purposes of the federal securities laws and, thus, holders of Warrants are protected by the antifraud provisions of the federal securities laws in connection with the purchase or sale of the Warrants.  The California Bankers Association said that California banks are not expected to accept Warrants after July 10, 2009.