June 4, 1985

Dear Mr. ________:
This is in response to your request for our opinion on the propriety of ________ engaging in the sale of municipal bonds with a “put” option.
As we understand it, the transaction would be structured as follows: ________ (________) proposes to sell tax exempt bonds now held in the bank’s investment portfolio. These bonds were issued by various state or local governments. As of 3/31/85, these bonds had a book value of $22,638M and market value of $19,322M.
Bonds to be offered for sale will be in denominations of $5,000 (except in the case of one bond which will be in the denomination of $1,000) in principal amount. Each bond will be priced individually, but ________, the tender and remarketing agent, will underwrite the whole transaction. Per bank management, the underwriting price will be approximately $24,254M or 95% of the total par value of the bonds.
________ will issue a “put” with each bond sold. If the underlying bond is not in default, a “put” will entitle the purchaser or subsequent transferee to tender to ________ for repurchase the bond and the “put”. Under the put, there will be two tender periods. The initial tender period will be after two years from the sale of the bonds. The second tender period will be after two years from the initial tender period. On the initial tender period, ________ will first attempt to resell the tendered bonds and puts on behalf of their owners. If no new purchaser are found within a prescribed time, ________ will exercise such puts on behalf of the putholders so that ________ will purchase the tendered bonds at the “strike price” set by the put plus accrued and unpaid interest on the bonds. Per bank management, “strike price” is approximately 97.5% of the bonds par value.
________ obligation to honor the puts will be secured by irrevocable letters of credit issued by ________ (________).________ will invest the proceeds from the sale of the bonds in certificates of deposits with major banks including ________. The certificate of deposits will be pledged as collateral for the letters of credit.
________ described the accounting treatment for the proposed transaction in a letter to Assistant Deputy James Brodie dated 3/29/85. ________ sale of the bonds will be accounted for as a borrowing transaction. As such, no loss from the sale of the bonds will be recognized until the puts have either been exercised or expired. The difference between the sale proceeds and the put price will be accrued as interest expense. Expenses relating to the sale estimated at $626M (underwriting fees, accounting and legal fees, etc.) will be amortized over the term of the puts.
The accounting for the transaction will consist of selling the bonds for approximately $24,254M and debiting Cash & Due From, with the offsetting credit reflected under borrowings. However, the book value of the bonds sold will remain as an asset on the bank’s books. The difference between the sale proceeds and the put price will be accrued as interest expenses over the initial two-year period. The estimated expenses of approximately $626M will be amortized over the initial two-year period.
Based upon your representation above concerning the transaction, we would conclude that such transactions fall under the borrowing for temporary purposes contemplated by Financial Code Section 1202. In so concluding, we note that the “put” is for a fixed period of time; that the time is not an unreasonable period of time in view of the nature of the transaction; that the “put” may not in fact be exercised; and, that if exercised the bank has funds set aside for such specific purpose, and repayment of the borrowing is not dependent upon contemplated future earnings.
Consequently, if the transaction as mentioned above is correct and is in accordance with GAAP, we would interpose no objection to this transaction. However, our Examiners will review the transaction for safety and soundness at our next examination. Once the transaction is consummated, we would appreciate receiving a copy of the executed agreements for our files.
Very truly yours,
Superintendent of Banks
Deputy Superintendent of Banks

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