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Harris Savings Bank

FEDERAL DEPOSIT INSURANCE CORPORATION

IN RE: Harris Savings Bank Harrisburg, Pennsylvania

Application Pursuant to Section 24 of the Federal Deposit Insurance Act for Consent to Continue To Indirectly Engage as Principal Through a Majority-Owned Subsidiary in a Real Estate Activity That May Not Be Permissible for a Subsidiary of a National Bank

ORDER

The Board of Directors ("Board") of the Federal Deposit Insurance Corporation ("FDIC") has fully considered all available facts and information relevant to section 24 of the Federal Deposit Insurance Act, 12 U.S.C. Sect.1831a, and Part 362 of the FDIC Rules and Regulations, relating to an application by Harris Savings Bank, Harrisburg, Pennsylvania (the "Bank"), for consent to continue to indirectly engage as principal through H S Service Corporation, a majority- owned subsidiary (the "Subsidiary"), in an activity that may not be permissible for a subsidiary of a national bank. The Board, having found that the Bank is in compliance with applicable capital standards and that the activity to be continued does not appear to pose, with certain conditions imposed, a significant risk to the applicable deposit insurance fund, has concluded the application should be approved subject to certain conditions.

Accordingly, it is hereby ORDERED, for the reasons set forth in the attached Statement, that the application submitted by the Bank for consent to continue to indirectly engage as principal through the Subsidiary in an activity that may not be permissible for a subsidiary of a national bank be, and the same hereby is, approved subject to the following conditions:

1. That the Bank shall take the necessary actions to establish the Subsidiary, and operate the Subsidiary in a manner so as to ensure that it has a separate corporate existence as a majority-owned subsidiary which:

(a) is adequately capitalized,

(b) is physically separate and distinct in its operations from the operations of the Bank,

(c) maintains separate accounting and other corporate records,

(d) observes separate formalities such as separate board of directors' meetings,

(e) maintains a board of directors with one or more independent, knowledgeable outside directors and management expertise capable of conducting activities in a safe and sound manner,

(f) contracts with the Bank for any service on terms and conditions comparable to those available to or from independent entities, and

(g) conducts business pursuant to separate policies and procedures designed to inform customers and prospective customers of the Subsidiary that the Subsidiary is a separate organization from the Bank, including the placement of specific language on any debt instrument or contract with a third party disclosing that the Bank itself is not responsible for payment or performance.

2. That the Bank's indirect real estate investment in the Subsidiary, including equity interests, debt obligations of the Subsidiary held by the Bank, Bank guarantees of debt obligations issued by the Subsidiary, extensions of credit or commitments of credit from the Bank to the Subsidiary, and any extensions or commitments of credit to any third party for the purpose of making a direct investment in the Subsidiary or making an investment in any investment in which the Subsidiary has an interest (defined collectively as "Real Estate Investment"), shall be limited to not more than 10 percent of Tier 1 capital. For purposes of this Order, Real Estate Investment shall not include loans made by the Bank to finance bona fide sales of assets which meet the requirements of paragraph 8(b) below.

3. That the Bank's capital level, after deducting all Real Estate Investments in the Subsidiary, shall equal or exceed the level required for a "well capitalized" institution pursuant to section 325.103(b)(1) of the FDIC's Rules and Regulations.

4. The Bank shall, on a quarterly basis, perform the capital adequacy calculations described in paragraph 3 above for the purpose of ascertaining its capital level, and that, in the event the Bank falls below the level required for a "well capitalized" institution pursuant to section 325.103(b)(1) of the FDIC's Rules and Regulations, the Bank shall notify the FDIC within 15 days and submit to the FDIC an acceptable plan for restoring capital to a level required for a "well capitalized" institution.

5. That, henceforth, notwithstanding Parts 325 and 327 of the FDIC's Rules and Regulations, 12 C.F.R. Parts 325 and 327, the Bank's capital category for purposes of prompt corrective action and the Bank's risk adjusted deposit insurance premium shall be calculated based on the Bank's capital after deducting all Real Estate Investments, except that such deductions shall not be made when determining whether the Bank is "critically undercapitalized" as defined under Part 325.

6. That any extensions of credit to any third parties for the purpose of making a direct investment in the Subsidiary, or making an investment in any investment in which the Subsidiary has an interest, or any acceptance of any debt obligation of or equity interest in the Subsidiary as collateral security for a loan or extension of credit to any third party by the Bank shall be clearly disclosed to the Bank's board of directors prior to approval of the extension of credit and documented in the board's minutes.

7. That the Bank and Subsidiary shall not engage in any transactions with insiders of the Bank or their related interests which relate to the Subsidiary's real estate investment activities without the prior written consent of the appropriate Regional Director of the FDIC's Division of Supervision.

8. That the Bank shall:

(a) not condition any loan on the purchase or rental of real estate from the Subsidiary, and

(b) not extend credit to any borrower to acquire real estate from the Subsidiary unless it is consistent with safe and sound banking practice and does not involve more than the normal degree of risk of repayment and the credit is extended on terms and under circumstances, including credit standards, that are substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions.

9. That transactions between the Bank and the Subsidiary shall be made in accordance with the restrictions of sections 23A and 23B of the Federal Reserve Act, 12 U.S.C. Sect. 371c and Sect. 371c-l, to the same extent as though the Subsidiary were an affiliate of the Bank as defined under sections 23A and 23B, with the exception that the collateral requirements of section 23A shall not apply to existing loans. Furthermore, the collateral and investment limitations of section 23A shall not apply to loans made by the Bank to finance bona fide sales of assets to third parties consistent with safe and sound underwriting requirements contained in paragraph 8(b) above.

10. That the consent granted herein is based on the facts and circumstances presented or otherwise known to the FDIC in connection with these requests. The Bank shall notify the FDIC of any significant change in facts or circumstances. If the facts and circumstances change significantly, the FDIC shall have the right to alter, suspend, or withdraw its approval.

Dated at Washington, D. C., this 3rd day of December, 1996.

BY ORDER OF THE BOARD OF DIRECTORS

Jerry L.Langley
Executive Secretary


FEDERAL DEPOSIT INSURANCE CORPORATION

IN RE: Harris Savings Bank Harrisburg, Pennsylvania

Application Pursuant to Section 24 of the Federal Deposit Insurance Act for Consent to Continue To Indirectly Engage as Principal Through a Majority-Owned Subsidiary in a Real Estate Activity That May Not Be Permissible for a Subsidiary of a National Bank

STATEMENT

Pursuant to the provisions of section 24 of the Federal Deposit Insurance ("FDI") Act, Harris Savings Bank, Harrisburg, Pennsylvania (the "Bank") has filed an application with the Federal Deposit Insurance Corporation ("FDIC"). The applicant requests the FDIC's consent to continue to indirectly engage as principal through H S Service Corporation, a majority-owned subsidiary (the "Subsidiary"), in an activity that may not be permissible for a subsidiary of a national bank.

The activity of holding real estate investment properties may not be a permissible activity for a National bank or a subsidiary of a National bank. State-chartered FDIC-insured banks may not engage as principal in an activity prohibited to nationally-chartered banks unless they obtain consent from the FDIC. Consent may not be granted unless the bank is in compliance with applicable capital standards and the FDIC determines that the activity poses no significant risk to the deposit insurance fund. Pennsylvania State law permits the holding of real estate investment properties by savings banks and their subsidiaries.

The Bank proposes to complete development of two sub-divisions that represent the final phases of projects in which the Subsidiary already has an interest, with the single-family home lots to be sold to contractors or individuals. In addition, the Bank seeks approval to engage in future projects through the Subsidiary if profitable opportunities arise.

Investments in real estate, at any stage of the development process or even completed properties, can be generally characterized as quite risky in that there is a high degree of variability or uncertainty of returns on invested funds. The cyclical downturn in the real estate market in the late 1980's and early 1990's, and the impact of that downturn on financial institutions, provides an illustration of the market risk presented by real estate investment. In addition to the high degree of variability, real estate investments possess many risks that, while not entirely unique, are not readily comparable to typical equity investments (e.g., common stock). Real estate markets are for the most part localized, investments are normally not securitized, financial information flow is often poor, and the market is generally not very liquid.

Real estate investment risk is higher than for most traditional bank assets, such as loans or debt securities. Real estate investment can increase interest rate risk; optimum investment periods are typically longterm; real estate is relatively lacking in liquidity; and real estate is subject to specialized risks such as environmental liability. In addition, real estate investment is of questionable benefit in the diversification of a financial institution's portfolio of assets. The experience and expertise of management is a critical factor, and there is much anecdotal evidence to suggest that the lack of adequate management creates a significant level of risk of loss.

Due to these risks, real estate investment activities appear suitable to a financial institution only on a very limited scale and under restrictive conditions designed to control the various risks posed to the financial institution and the deposit insurance fund.

The FDIC has reviewed available information and has also taken into consideration the financial and managerial resources and future earnings prospects of the Bank. The FDIC also considered the risks associated with real estate investment activities and the risks associated with the development of residential real estate properties.

In determining if a significant risk to the deposit insurance fund exists in the proposal, the FDIC evaluated the specifics of the Bank's application. In evaluating a section 24 real estate activity application, the FDIC considers the types of real estate investment activity proposed to determine if any activity is unsuitable for an insured depository institution. The proposed subsidiary structure and its management policies and practices are reviewed to determine if a bank is adequately protected from litigation risk. Capital adequacy is analyzed to ensure the Bank first devotes sufficient capital to its more traditional banking activities. Capital adequacy is determined by the Bank's "consolidated" and "bank only" leverage and risk-based capital ratios, with all investments in real estate investment subsidiaries excluded from capital in the "bank only" capital calculation. Limitations on investment in a subsidiary engaged in real estate investment activity are evaluated in order to assure that the maximum risk exposure is nominal. Policies relating to extensions of credit to third parties for subsidiary-related transactions are evaluated to determine if they protect the Bank from concentrations of risk. The Bank's policies on engaging in transactions in which insiders are involved are reviewed to determine if they protect the Bank from potential insider abuse. A bank's policies relating to the conditioning of loans on the purchase of real estate from the subsidiary and the extending of credit by the Bank to third parties for the purpose of acquiring real estate from its subsidiary are reviewed to determine if they prevent undesirable tying relationships and to determine if they are adequate to ensure that sound credit underwriting is maintained. Having reviewed these areas, the FDIC is imposing conditions for prudential reasons due to the volatility and other risks which are inherent in the subject real estate activity, as well as to mitigate any potential insider conflicts of interest and to reduce risk to the deposit insurance fund.

The Bank's proposed level of investment in and loans to the Subsidiary represent approximately 6.5 percent of its Tier 1 capital. The Bank committed to the FDIC that its investment in the Subsidiary will be limited to not more than 10 percent of its equity capital. This level is within acceptable risk standards and such a limitation is imposed on the aggregate level of the Bank's existing and future real estate activity.

In order to ensure the Bank's capital is sufficient to support both traditional banking activities and real estate investment activities, the FDIC will also require that the Bank's capital, after deducting the Bank's aggregate investment, including the proposed investment, in the Subsidiary, equal or exceed the level required for a "well capitalized" institution pursuant to section 325.103(b)(1) of the FDIC's Rules and Regulations. In order to promote the concept that real estate investment activities should be conducted in a separately and adequately capitalized subsidiary and to ensure that the appropriate deposit insurance fund is adequately compensated for, and sufficiently protected from, additional risk in the event that "bank only" capital levels fall below "well-capitalized" levels, the Bank's capital category for purposes of Prompt Corrective Action will be determined, and the Bank's risk adjusted deposit insurance premium will be assessed, based on "bank only" capital ratios except for the purposes of determining if the Bank is "critically undercapitalized." As an incremental step towards corporate separateness, the Subsidiary is required to maintain a board of directors with at least one director who is not a director, officer, or employee of the Bank.

Given the high risk present in real estate investment activities, the FDIC has also imposed a condition requiring that transactions between the Bank and the Subsidiary shall be made in accordance with the restrictions of section 23A and 23B of the Federal Reserve Act to the same extent as though the Subsidiary were an affiliate of the Bank as defined under sections 23A and 23B. An exception to this restriction is that the collateral requirements of section 23A shall not apply to existing loans. In addition, the collateral requirements and investment limitations of section 23A shall not apply to loans made by the Bank to finance bona fide sales of assets to third parties, provided that: 1) any such loans are consistent with safe and sound banking practice; 2) do not involve more than the normal degree of risk of repayment; and 3) the loans are extended on terms and under circumstances, including credit standards, that are substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions. Any such loans made by the Bank would be reviewed by examiners at each regular safety and soundness examination conducted by the FDIC. The Bank may not condition any loan on the purchase or rental of real estate from the Subsidiary. In addition, the FDIC has imposed conditions relating to transactions with insiders and loans to third parties for investment in the Subsidiary or real estate in which the Subsidiary has an interest.

For the reasons outlined above, including the imposition of conditions, the Board of Directors has concluded that the retention of interest in real estate does not pose a significant risk to the Bank Insurance Fund, provided the conditions are observed, and therefore approval of the application, subject to such conditions in the Order, is warranted.

THE BOARD OF DIRECTORS
FEDERAL DEPOSIT INSURANCE CORPORATION



Last Updated 03/24/2011 Legal@fdic.gov