September 12, 2002
The Honorable Alan Greenspan The Honorable John D. Hawke, Jr. The Honorable David M. Walker Dear Chairman Greenspan and Messrs. Hawke and Walker: I am writing to acknowledge receipt of the August 13, 2002, joint letter from the Board of Governors of the Federal Reserve System (Federal Reserve) and the Office of Comptroller of the Currency (OCC), as well as the August 20, 2002, letter from the U.S. General Accounting Office (GAO), in response to my July 11, 2002 letters to you regarding banks tying the availability or price of credit to investment banking services. These activities constitute unsafe and unsound banking practices and pose a potential threat to consumers. See, for example, "Surprise! The Little Guy Loses," Business Week (July 8, 2002) at 42 ("The banks have become masters at offloading the financial risks of their lending by repackaging and selling it to pension and mutual funds, insurance companies, and even ordinary investors."). First, I appreciate the assurances of the Federal Reserve and the OCC that you share my concerns and will continue your supervisory efforts to ensure compliance with sections 106 and 23B, other banking statutes, and safe and sound banking practices. However, I am not at all convinced by your assurances that no mispricing or tying is occurring. Your responses to my questions are helpful and much appreciated but they raise additional questions. Accordingly, I request your responses by the close of business on Friday, October 11, 2002, to the followup questions that I am enclosing as Appendix A to this letter. Second, I am pleased that GAO has accepted my request for an investigation and report as work that is within the scope of your authority and that you anticipate being able to start this project relatively soon. I look forward to working with you on this important issue and to receiving the results of your respective reviews. Thank you for your cooperation and attention to this matter. Sincerely, JOHN D. DINGELL Enclosure cc: The Honorable W.J. (Billy) Tauzin, Chairman
Appendix A -- Followup Questions Have you reviewed the public statements of bank senior executives (see Appendix B to my July 11, 2002, letter) which state openly that bank credit is mispriced? Do you intend to interview any of these executives? 2. You cite the large number of participants in syndicated credit facilities as evidence that credit facilities are being priced at market. Specifically, you state that "in the syndicated loan market, 80 percent of the dollar amount of the commitments outstanding in 2001 or $1.6 trillion of the $2.0 trillion in commitments, involved nine or more participating banks and non-banks, a strong indicator that the loan was adequately priced on a stand-alone basis." Have you inquired of any of the smaller bank participants as to whether they are pressured by lead arrangers or corporate borrowers to enter into credit facilities as a condition to obtaining other business from the corporation? Have you asked any of these participants what price would be required to transfer these positions to other financial institutions who are not "relationship lenders" such as institutional investors? 3. You mention that "institutional bond investors have, over the past several years, increasingly looked to the syndicated and secondary loan markets for investment candidates." Have you had discussions with these institutional investors to determine what types of credit facilities they participate in? Available information appears to show that these investors participate entirely in funded loans for non-investment grade credits or in distressed bank loans. With rare exception, they do not participate in the mispriced unfunded credit facilities which are almost exclusively provided by commercial or investment banks. 4. Certain institutional lenders and smaller banks purchase unfunded credit facilities at a steep discount following primary syndication. Have you asked any such investors about such transactions and how they determine the price at which they make such investments? 5. You state that "the extent to which the pricing of certain credit products in the past has not fully compensated lenders for the ultimate risks undertaken may reflect a cyclical over-optimism about the fundamental credit condition of the borrowers at the time the credit extension was made," but that "any past mispricing is currently being corrected." Have you reviewed historic data on loan commitment pricing (particularly the critical components of such instruments, the unfunded commitment fees)? The evidence in such data appears to clearly suggest that, far from being corrected, the mispricing has increased as credit spreads have widened in the capital markets, reflecting the difficult current economic environment, whereas pricing on revolving credit facilities has remained constant. Please explain how you could compare pricing of loan commitments to large corporations with corporate bond and credit default swap pricing of those same borrowers and conclude that these instruments are being priced at market. 6. Many banks use fair value accounting for internal risk management and for management accounting. We understand that these internal accounting models reflect the fact that credit is being provided at below market prices (for example, securities affiliates are charged extra costs for providing credit to corporate clients.) Have you made any inquiries as to the differences between internal and external financial reporting systems for corporate credit facilities? 7. You reference the requirement under GAAP for banks to disclose in financial statement footnotes the fair value of assets, liabilities, and commitments that are financial instruments (FAS 107). Given the significant evidence of mispricing of loan commitments referred to in the preceding questions, have you reviewed the methodologies used by banks in preparing FAS 107 disclosures and whether such disclosures properly reflect the fair value of these instruments? Are the FAS 107 disclosures consistent with the banks’ internal and management accounting for these instruments? 8. You indicate that FRB and OCC staff are conducting a special targeted review of the circumstances described in the press and referenced in my letter. You say that you will review the antitying training and compliance programs, marketing programs, training materials and adequacy of internal audits for compliance with the bank’s internal policies and procedures at several of the country’s largest banks. I note your comments on the proposed nature of the targeted reviews. Since tying, however, is understandably never done in written form, do you intend to directly question bank officials about whether they violate formal written policies in verbal communications with corporate borrowers? For example, will you ask them whether, notwithstanding any such policies or procedures, they ever request that a borrower provide investment banking business as a condition of extending or renewing a credit facility? Will you specifically investigate any of the widely publicized reports of tying in cases such as Phillip Morris Cos.’ multi-billion-dollar initial public offering (IPO) spin off of its Kraft Foods Inc. subsidiary, Lucent’s IPO spin off of Agere Systems Inc., Motorola, Corning, and Vivendi? I am transmitting copies of complaints that I have received involving Bank of America and Westdeutsche Landesbank. I also note that it has been widely reported that Enron’s treasury staff systematically linked fee-based business to credit extension. Do you intend to contact corporate financial executives to inquire as to whether they feel pressure to award investment banking or other services as a condition to obtaining commercial bank participation in loans? (See the October 2001 Greenwich Associates Survey of Corporate Executives.)
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