What it means
In the late 1980s a large number of savings and loan associations failed, and the government needed cash quickly to close them, pay their depositors and sell off their assets. Congress created REFCORP to borrow that money from investors instead of paying for it immediately out of the federal budget.
It was a financing arm, not an operating business, and it never made loans to the public. The corporation issued long-dated bonds in the early 1990s and used the proceeds to fund the agency that handled the failed institutions.
To make the bonds safe, it bought zero-coupon Treasury securities (bonds that pay no interest along the way and are repaid in one lump sum) to cover the principal at maturity. That structure meant investors knew the face value would be paid when the bonds fell due.
The interest was a separate matter. It was paid from contributions made by the Federal Home Loan Banks, a system of regional banks owned by the lenders that use them, with the Treasury standing behind any shortfall.
For years the Federal Home Loan Banks gave up a set share of their annual earnings to make those payments, and that share was historically 20%. For investors, REFCORP bonds were regarded as very high quality because of that combination of Treasury-backed principal and government-linked interest support.
They traded at a small yield premium to Treasuries, which reflected the fact that they were less liquid and carried indirect rather than direct government backing. Fund managers valued them as a way of earning a little extra yield without moving far from government credit.
The important nuance for a modern reader is that REFCORP is a closed chapter. The corporation was never a lender to businesses or households, and its obligations are finite and long since planned.
The term remains useful because it shows how a government can separate the financing of a rescue from its ordinary budget and spread the cost over decades.
In practice
Real-world examples.
Example
A fixed income analyst reading a pension fund's bond report sees a holding labelled as a REFCORP strip. She learns that it is a zero-coupon security backed by the principal arrangements of the corporation, and she values it like a very safe discount bond. She also records the maturity date in the cash plan.
Example
A finance student writing a paper on the savings and loan crisis uses REFCORP to explain how the cost of the clean-up was financed. She shows that the interest was funded by an assessment on the regional home loan banks and not by a new tax on the public.
Example
A treasury manager at a small insurer compares an older REFCORP holding with a Treasury bond of the same maturity. The REFCORP bond pays a slightly higher yield, but its price is harder to find, and he notes that choice when he reports the portfolio's liquidity.
Case study
Seen in the real world.
Stonebridge Mutual is an illustrative, fictional insurance company that has held a small block of REFCORP strips for many years. When the new head of investments reviewed the portfolio, she found the securities listed under an unfamiliar name and asked why the firm had bought them.
The previous manager's notes explained that they had been chosen for their combination of high credit quality and a slightly better yield than Treasuries. She checked the pricing and found that, although trading was thin, the securities could still be sold within a few days at a fair price.
She kept the holding but added a line to the investment report explaining what the securities were and how they behaved. The illustrative lesson is that unfamiliar names in a portfolio deserve a short written explanation, and a clear history makes later reviews faster and calmer. The new note also records the maturity date, so the team knows when the cash will come back.
Watch out
Common mistakes.
- Treating REFCORP as a lender that is still active, when it was a one-purpose financing vehicle created for a specific rescue.
- Assuming REFCORP bonds carry exactly the same backing as Treasury bonds, when the backing for principal and interest was arranged differently.
- Forgetting liquidity, since thinly traded older bonds can be hard to sell at the price an investor expects.
Questions
People also ask.
What did REFCORP pay for?
It raised money to fund the resolution of failed savings and loan associations, including paying depositors and selling off the institutions' assets.
Who paid the interest on REFCORP bonds?
The Federal Home Loan Banks made annual contributions from their earnings, and the Treasury was there to cover any shortfall.
Why does it still matter?
It is a clear example of how a government can finance a clean-up with long-dated bonds, and it still appears in older bond portfolios and in teaching material.
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