Loopholes in the BHC Act:  The Bank Holding Company Act, among other things, lays down rules regarding companies that own an insured depository institution.   Whereas the BHCs are subject to consolidated supervision and regulation by the Federal Reserve, and non-banking activity resrtictions of the BHC Act, comapnies owning a FDIC insured thrift, industrial loan company, credit card Bank, trust company, or grandfathered depsitory institution are not required to beomce BHCs.

The result of the above was that, some investment banks and insurance companies were able to obtain access to the Federal safety net by tactically owning depository institututions not considered as Banks.   That apart, they were also able to escape more stringent regulation and restrictions on their non banking activity.   They were also emboldened to leverage their off balance sheet exposures without adequate capital support.

Supervision of such firms became difficult on account of the complexity of their operations and indeed their structures.

The proposed reforms package would eliminate the different supervisory and regulatory regimes for thrifts and the BHCs, that have provided arbitrage opportunities to the Banks.

The Industrial loan companies have become vehicles of commercial activities by financial firms on account of their FDIC  affiliation that offers them the federal safety net.   By owning such ILCs, commercial firms were avoiding provisions of the BHC Act.   Under the reforms package, the holding companies of ILCs would become BHCs.

Credit Card Banks also enjoy exceptions under the BHC Act.   And as such have become targets of financial firms to take advantage of leverage opportunities they offer to the parent company.

Trust companies, though, do not receive federal benefits on par with ILCs or credit card Banks, they also offer scope to financial firms in the same manner though on a smaller scale.

Under the new financial regulatory regime, holding companies of NBB would also become BHCs.

                                                                                         To be concluded.

Category-wise review and assessment:  The SCAP supervisors applied a range of models and tools in carrying out the review and assessment of the submissions of the 19 BHCs.   We shall study, in detail, the category-wise review and assessment done in regard to the following:  first and second lien mortgages, credit cards and other consumer loans, commercial and industrial loans, commercial real estate loans, other loans, securities in available for sale and held to maturity portfolios, trading portfolio losses,  counterparty credit risk, pre-provision net revenue, and allowance for loan and lease losses.

First and Second Lien Mortgages:  Residential mortgages were an area where many of the BHCs took a big hit on their bottomlines.   The firms submitted information relating to this portfolio, the methods adopted to project losses, the important underlying assumptions in the methods adopted, etc.   Apart from this, at the instance of the supervisors, the firms also provided the following information about their residential mortgages:

1. Type of product
2. Loan to Value Ratio
3. FICO score
4. Geography
5. Level of documentation
6. Year of origination
7. Other relevant features

The agencies evaluated the first mortgages, home equity lines of credit, and closed end second mortgage products seperately.   They evaluated submissions of each firm in regard to the model, assumptions, and circumstances independently, as well as in relation to the peers in the group, to make any adjustments, if necessary.   The firms’ assumptions regarding prepayment of existing loans, and availability of new limits was normalized to make generally consistent across firms.   Each firm’s portfolios were analyzed by taking into account the unique features of the portfolio, and application of common loss estimation methodologies in the backdrop of industry-wide data.   Where any particular characterisitc of the loan portfolio like FICO, LTV bands, etc., provided any indication of defaults, they were applied more intensively to evaluate the submissions and make necessary adjustments to them.

Credit Cards and other Consumer Loans:  In case of credit cards, the methods used by the firms to project losses were in relation to the two macroeconomic scenarios.   Each of the firm’s results were benchmarked against historical trends in such portfolios comprising of loss, paydown/runoff, roll rates, utilization, etc.   Fhe firms submitted information called for about credit cards on the FICO scores, payment rates, utilization rates, geographic concentration, etc.

The supervisors, in addition to using existing models to evaluate the firms’ credit card loan loss projections and resources, also developed risk profiles suited to specific portfolios, that enabled them to make cross-firm comparisons.   That, in turn, revealed whether the firms had furnished reasonably accurate submissions.  It was found that, generally, the results obtained by the supervisors were relatively close to those of the BHCs.

Coming to the other loans, the bulk of which were auto loans, personal loans, and student loans, the firms submitted information on FICO scores, LTV, Term, vehicle age, and geographic concentratin.   The above data was examined in detail, alongwith the embedded components of each firm’s portfolios.   Further, historical loss experience, and performance measures were examined to arrive at the acceptable level of projected losses.

                                                                                                     To be concluded. 

Acknowledgement:  Adapted from the official document of the Board of Governors of the Federal Reserve System.

Types of Leasing:   There are basically two types of leasing-the Finance Lease or Capital Lease, and the Operating Lease.

Finance Lease:  A Finance Lease, also called a Capital Lease, is a commercial contract, wherein the lessor, at the instance of the lessee, places an order for an asset, as per specifications provided by the lessee, and such asset is leased out to the lessee, on certain terms and conditions.

The standard terms and conditions in a lease contract like this, is that the ownership of the asset remains with the lessor, and the lessee will have the right to the beneficial use of the asset.   Further,  he would be obliged to take proper care of the asset, and ensure its upkeep.   And as a consideration for the use of the asset, the lessee would have to pay a certain sum of money every month in the form of lease rentals.

At the end of the lease period, the lessee would have the option to buy out the asset from the lessor, at a very attractive price.   And since it is he that has used the asset all the time, the lessee is sure of the quality and the remaining life of the asset, which enables him to take a correct decision.   As for the lessor, he would have recovered the major part of  his investment on the asset from the lease rentals, and would also have the benefit of the residual value of the asset, that he could sell to the lessee, or others.

Operating Lease:  A Operating Lease is similar to a Capital or Finance Lease, to the extent that the ownership of the asset lies with the Lessor.   And the Lessee enjoys the constructive possession of the asset, enabling him to make money out of the same, without actually owning the asset.  

However, the operating lease cycle is generally for a shorter period vis a vis the life of the asset.   For instance, if the productive life of the asset is, say, 20 years, then the lease period may be only for 5 years.   Operating lease, generally, does not provide for the sale of the asset at the end of the lease period.

Difference between Finance Lease and Operating Lease: 

The Finance lease is generally long term, covering almost the entire productive life of the asset, whereas the Operating Lease is generally short term in comparison.

The Finance Lease provides for the purchase of the asset by the lessee at the end of the lease period, which is not the case with the Operating lease.

In the Finance lease, the lessor recovers the major part of his investment in the asset, if not the entire cost, and the residual value of the asset is not much.   Whereas, in the Operating lease, since the lease period is a short one, the lessor does not recover the major part of his investment in the asset.   However, the residual value of the asset is quite high.

Generally, the Finance lease may work out to be cheaper option to the lessee compared to the Operating lease, as in the latter case,  the monthly rentals, would in all probability, include a risk premium.

Summary:  Leasing, as a financing option, has its pluses and minuses.   It really depends upon the requirements of the lessee, and how much freedom he has to exercise his options for other, cheaper sources of finance.

                                                                                                             Concluded