Q&A with Emily Hollis

Emily Hollis
January 13, 2009 | COMMENTS

Question: Have you heard about the major banks issuing debt that is guaranteed by the United Stated government? Where are these securities trading and can credit unions invest in these vehicles?

Major banks and capital corporations are raising funds in the secondary markets under this new program, which is one of numerous steps taken by the government to stabilize the credit markets and stimulate lending. The debt is guaranteed under the Federal Deposit Insurance Corporation's (FDIC) Temporary Liquidity Guarantee Program (TGLP) and is backed by the full faith and credit of the United States . The expiration of the FDIC's guarantee is the earlier of either the maturity date of the issued debt or June 2012. Not only are major banks issuing this debt, but so are financing companies such as General Electric Capital Corporation. The securities were issued in November and early December 2008 at approximately 1.5% to 2% higher than relative Treasuries. Spreads have tightened to 0.75% to 1.25% at an approximate yield of 2.7% for a three-year security. The minimum purchase amount is generally $100,000.

Experts in the industry estimate that financial institutions may use this program to issue $250 to $350 billion in debt over the next six months. This could really help financial institutions make a dent in the $233 billion of debt they have to repay or refinance over the next five quarters, according to Standard & Poor's.

Credit unions are allowed to purchase these securities in accordance with Section 107 (7) of the Credit Union Act:

(7) To invest its funds (A) in loans exclusively to members; (B) in obligations of the United States of America, or securities fully guaranteed as to principal and interest thereby . . . or in obligations, participations, securities, or other instruments of, or issued by, or fully guaranteed as to principal and interest by any other agency of the United States.

Although the investments have the FDIC backing, further review of the prospectus is warranted. The program is new and is subject change. In other words, the final rules adopted by the FDIC on November 21, 2008 may be amended and therefore are subject to ongoing interpretation by the FDIC. The securities can be redeemed before they mature by the issuer if they become obligated to pay additional amounts because of changes in U.S. withholding tax requirements.

Another minor risk is the loss of right to payment should the trustee fail to follow the FDIC claims process; however, this statement is fairly common in all FDIC insured investments.

I never thought I would see the day that major broker/dealers are allowed to issue “synthetic” Treasury bonds. The FDIC guarantee actually makes these bonds have less credit risk than Fannie Mae and Freddie Mac agency securities.

Emily Hollis is a CFA and president of ALM First Financial Advisors in Dallas, Texas. Contact Hollis at 800-752-4628 or ehollis@almfirst.com.