PURPOSE: Because of the competition with the money market funds and other financial institutions, many state-chartered banks are aggressively marketing retail repos. The legal and practical problems of marketing retail repos make it absolutely essential that the bank obtain sound legal and financial advice before entering this program. This rule provides a very general guide to the legal pitfalls which await the bank entering the retail repo market without an understanding of the underlying transaction.

1. (1) Introduction. The eighty-nine (89)-day repurchase agreement, referred to as a retail repo, is a relatively new instrument, but it is used today by a substantial number of banks and is gaining in popularity as a result of the FINANCIAL INSTITUTIONS AND PROFESSIONAL REGISTRATION

intense competition among the various financial institutions for the depositors’ funds. It was created in August of 1973 as a result, ironically, of attempts by the federal regulatory agencies to curb the use of repurchase agreements which the agencies feared would become devices for evasion of limits on interest in Regulation Q. Prior to August 1979, repurchase agreements were exempt from Regulation Q because they were considered to be transactions in securities rather than deposits. In that month, however, the agencies limited the exemption, where the amount involved was less than one hundred thousand dollars ($100,000), so that it now applies only to an evidence of indebtedness arising from a transfer of direct obligations of, or obligations that are fully guaranteed as to principal and interest by the United States or any agencies that the bank is obligated to repurchase, and is “in denominations of less than $100,000, matures in less than ninety (90) days and cannot lie automatically renewed or extended.” (12 CFR Section 329.10(b)(2))

1. (2) Power to Issue. State-chartered banks are authorized to engage in the retail repo market by section 362.105, RSMo. The first paragraph of that section authorizes every bank and trust company to conduct the business of “buying, investing in, selling and discounting negotiable and nonnegotiable paper of all kinds.” Furthermore, section 362.170, RSMo specifically exempts from the legal loan limits evidences of debt of the United States and evidences of debt as to which the United States has “guaranteed or contracted to provide funds to pay both principal and interest.” Banks can legally invest in government obligations without limitation and the power to buy in this context carries with it the power to sell.

2. (3) Areas of Concern.

   1. (A) Banks which are marketing retail repos or which are considering retail repos are warned that the law governing these obligations is somewhat uncertain and nowhere is this more true than in the area of securities laws. Accordingly, it would be imprudent for banks to begin the marketing of retail repos without obtaining sound advice from legal counsel or a correspondent bank or other consultant knowledgeable in the field.
   2. (B) Perhaps the most important thing to keep in mind about retail repos is that these instruments constitute securities under almost any definition of that term. While bankissued securities are exempt from the filing requirements of most securities laws, they are not exempt from the fraud provisions of those laws. The repo is an obligation of the bank and because it is a security the bank should disclose all facts which are material to a potential buyer’s decision to invest or not invest. The bank should disclose that the obligation is not a deposit and, therefore, is not insured by the Federal Deposit Insurance Corporation. In addition, since the repos will be redeemed by the bank out of general funds, the principal security of the investor beyond the capital of the bank is the underlying government security. When the market value of the underlying government security is less than the aggregate amount owed by the bank pursuant to all repos matched to the underlying government security, investors should be advised that they will be unsecured creditors to the extent of their pro rata share of the difference. The bank should also disclose to investors their creditor status in the event of involuntary liquidation proceedings, which may take the form of straight receivership liquidations or so-called purchase and assumption liquidation proceedings. Any other facts relevant to the bank’s ability to repay or the safety and security of the collateral should also be disclosed.
   3. (C) The bank should arrange for a third party such as a correspondent bank or a Federal Reserve Bank to act as custodian or trustee of the underlying government securities. There are two (2) reasons for this procedure. First, if the bank continues to hold the underlying government securities, there has been no transfer of the government obligations and the repo will probably not be exempt from Regulation Q. In addition, if the bank continues to hold the securities, the security agreement protecting the customer has not been perfected, and it will be necessary to disclose to the customer that if s/he invests it in the repo, s/he will become an unsecured creditor of the bank.
   4. (D) A bank is also well advised to apply some asset and liability management principles to the retail repo program to avoid interest rate and maturity gaps. If the bank purchases securities which have longer maturities than the repos themselves, rising interest rates may result in the bank paying more for its money than it is earning on the securities in which the money is invested. In addition, the liquidation value of government securities may drop during periods of rising interest rates and a bank may be unable to redeem a retail repo using only the proceeds from the sale of the security.

AUTHORITY: sections 361.105, RSMo 1986, 362.105, RSMo Supp. 1991 and 362.170, RSMo Supp 1989.* This rule originally filed as 4 CSR 140-6.040. Original rule filed July 15, 1981, effective Nov. 15, 1981. Amended: Filed Aug. 7, 1992, effective Feb. 26, 1993. Moved to 20 CSR 1140-6.040, effective Aug. 28, 2006. *Original authority: 361.105, RSMo 1967; 362.105, RSMo 1939, amended 1949, 1963, 1965, 1967, 1977, 1983, 1986, 1990, 1991; and 362.170, RSMo 1939, amended 1941, 1943, 1945, 1959, 1963, 1967, 1977, 1981, 1983, 1985, 1989.