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4000 - Advisory Opinions


Exception to Prohibition on Acquisition of Equity Investments (FIRREA)

FDIC-90-8

January 29, 1990

Pamela E. F. LeCren, Counsel

On December 12, 1989 the FDIC's Board of Directors adopted an interim final amendment to Part 303 of the FDIC's regulations (12 C.F.R. 303.13) which among other things implemented the provisions of section 28(c) of the Federal Deposit Insurance Act ("FDI Act", 12 U.S.C. 1831e) as added to the FDI Act by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA"). That amendment was published in the Federal Register on December 29, 1989 (54 FR 53540, December 29, 1989). In brief, section 28(c) prohibits any state chartered savings association from directly acquiring after August 9, 1989 any equity investment of a type, or in an amount, that is not permissible for federal savings associations. Likewise, state chartered savings associations may not retain any such equity investment which was acquired prior to August 9, 1989. Nonconforming equity investments acquired prior to that date are required to be divested under the statute as quickly as prudently possible but in no event later than July 1, 1994. The FDIC may establish conditions and requirements governing the retention of nonconforming equity investments during the divestiture period.

The statute allows for an exception to the general prohibition on the acquisition of equity investments for the acquisition or retention of equity investments in a service corporation provided that the service corporation is engaging in activities that are permissible for a service corporation owned by a federal savings association and provided that the amount of the association's investment in the service corporation does not exceed what a federal savings association could invest in a service corporation. A state chartered association may be granted permission to acquire, or retain, an equity investment in a service corporation even if these requirements are not met provided that the association is in compliance with the fully phased-in capital standards prescribed by section 5(t) of the Home Owners Loan Act (12 U.S.C. 1464(t)) and the FDIC determines that the activities of the service corporation, as well as the amount of the association's investment in the service corporation, do not pose a significant risk to either of the deposit insurance funds administered by the FDIC.

You have requested an opinion as to the application of section 28(c) and Part 303 as amended to *** , a service corporation owned by *** . In particular you would like the FDIC's opinion as to whether *** may continue to meet its obligations under a management agreement into which *** entered on January 27, 1989 with *** . Pursuant to that agreement *** is required to act as funding partner in connection with the development of approximately *** residential lots in *** . *** will purchase the land and fund the construction of subdivision improvements and homes and *** will act as managing partner for the development. *** executive committee voted to approve entering into the partnership/management agreement with *** on September 21, 1989 and a "commitment" letter outlining the project was sent to *** on the same day. *** has obtained performance letters of credit for road and sewer system completion and *** has approved the plat for the subdivision. Closing on the land purchase was scheduled for December 21, 1989 but was put off because of the adoption of the FDIC's interim rule.

According to the information provided to this office by you, *** is a *** state chartered thrift. *** does not currently satisfy the fully phased-in capital requirements set forth in section 5(t) of the Home Owners Loan Act and its present level of investment in service corporations exceeds that permissible for a federal savings association. *** which was formed in 1977, is described as a wholly-owned real estate development subsidiary. (Approximately 80 percent of the projects in which it is involved are residential in nature.) Although *** total investment in service corporations exceeds that permissible for a federal savings association, the real estate development activities conducted by *** would be permissible for a service corporation owned by a federal association. (12 C.F.R. 545.74(c)(3)(vi), (vii), and (viii)).

Under section 28(c) of the FDI Act and section 303.13(d)(2) of the interim regulation, *** equity investment in *** is a nonconforming investment in a service corporation as *** investment in *** (in combination with its investment in other service corporation subsidiaries) exceeds that permissible for a federal savings association. Investors cannot, therefore, retain its equity investment in *** without the FDIC's consent.

Inasmuch as *** does not meet its fully phased-in capital requirements, permission to retain the service corporation cannot be granted. (Section 303.13(d)(2)(ii)). *** must therefore file a divestiture plan with the appropriate FDIC regional director of supervision setting forth the association's plan to accomplish divestiture as quickly as prudently possible but in no event later than July 1, 1994. It should be noted that if *** successfully reduces its investment in *** to a level below that permissible for a federal savings association, and assuming that *** activities remain limited to those permissible for a service corporation owned by a federal association, *** could be retained as a conforming investment in a service corporation, i.e., the requirement to divest will no longer apply.

In so far as to whether, in our opinion, *** may proceed with its obligations under the management agreement entered into in January, 1989, please be advised that it is our opinion that section 28(c) does not prohibit a real estate development service corporation which is subject to divestiture from continuing to operate during the divestiture period so long as that continued operation is consistent with the association's obligation to divest as quickly as prudently possible. Of course, the continued operation is also subject to the FDIC's ability to impose any requirements and restrictions it finds appropriate. (In connection with the review of an association's plan to divest a nonconforming real estate development service corporation the FDIC will impose whatever restrictions it finds necessary in its opinion to guard against any significant risk to the affected deposit insurance fund that may arise as a result of the planned continued operation of that service corporation during the divestiture period.)

In the instance of *** continued operation would include closing on the land which is the subject of the management agreement and fulfilling the remainder of the obligations under that agreement. The closing would be a violation of section 28(c)'s prohibition on the acquisition of an impermissible equity investment if *** directly acquired the real estate. Although the purchase of the land by *** might be considered an acquisition of an equity investment by *** under section 303.13 as the term "equity investment" is defined therein to include a direct or indirect ownership interest in real property (see section 303.13(a)(4) and (5)), to do so would be contrary to the express language of section 28(c). That section only prohibits direct acquisitions and clearly sanctions the ownership by state savings associations of service corporations that engage in activities permissible for service corporations owned by federal associations. Federal savings associations are expressly permitted to acquire service corporations that develop real estate which power includes purchasing land for development.

Any association that must divest a real estate development service corporation should keep in mind that additional acquisitions of land for development may be, depending upon all the facts and circumstances, inconsistent with an association's obligation to divest that service corporation as quickly as prudently possible. The FDIC will therefore expect any association that contemplates additional purchases of land, especially if in connection with the initiation of new joint ventures, to substantiate in its divestiture plan the basis for the association's determination that doing so is consistent with its obligation to accomplish divestiture as quickly as possible. Lastly, if an association's investment in its service corporation exceeds that permissible for a federal savings association, loans from the association to the service corporation will normally be considered inconsistent with the obligation to quickly divest provided those loans would be counted toward the investment limit of a federal association in its service corporation. (12 C.F.R. 545.74(a)(1), (2)).


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