4000 - Advisory Opinions
Application of Regulation O Executive Officer Lending Limits to State Nonmember Banks Pursuant to Section 306 of FDICIA
May 21, 1992
Richard M. Fraher, Regional Attorney
Your letter of April 28, 1992, which was addressed to Regional Counsel John Rubin, has been referred to me for response. You asked for an interpretation of the recent changes in the laws and regulations concerning lending limitations affecting your company's extensions of credit to one of your executive officers.
You described the situation as follows: An executive officer of your bank has two lines of credit from the bank. The first line is secured by his corporate interest and has a balance of $360,000 and a maturity date in January, 1993. The second line of credit is secured by an equity note on the officer's principal residence, which was purchased over 25 years ago. This line has a balance of $468,000 with a maturity date in January, 1993.
B. Questions Presented
1. Under recently enacted laws and regulations, what is the lending limit that will be applicable to the line of credit that is secured by the executive officer's corporate interest?
2. Under recently enacted laws and regulations, what is the lending limit that will be applicable to the line of credit that is secured by the executive officer's residence?
3. To the extent that the existing lines of credit do not comply with the limit created by recent changes in laws and regulations, how quickly must these loans be brought into compliance with the new lending limits?
4. "Could the $100,000 [an amount which you assumed to be the maximum amount of the extension of credit secured by the officer's corporate interest allowed under the new regulations] also be secured by the home if within loan to value limits?"
C. Brief Conclusions
1 and 2. Unless the existing lines of credit were made for the purpose of (i) educating the officer's children or (ii) purchasing, constructing, maintaining, or improving the officer's residence, and, in the latter case, were secured by a first lien on the residence, both of the existing extensions of credit will be subject to a new FDIC regulation, 12 C.F.R. § 337.3(c)(2). This regulation places an aggregate limit, which in no case may exceed $100,000, on all loans made by banks to their executive officers for any purpose other than the two specified above.
3. Extensions of credit which exist prior to the effective date of section 337.3(c)(2), which is May 28, 1992, must be brought into compliance with the new regulation according to the terms of a transitional rule which is described more fully below. An exception to the requirement of bringing such loans into compliance with the new restrictions is that any loan which is in existence prior to May 28, 1992, and which bears a specific maturity date of May 28, 1993 or later shall be repaid in accordance with its repayment schedule in existence on or before May 28, 1992.
4. The response to your last question is that the line which is currently secured by the officer's corporate interest theoretically could be secured by his residence if the resulting transaction would fall within established loan to value limits. However, under the new regulatory scheme, no greater lending capacity is gained simply by using the officer's residence as collateral.
D. Recent Changes in Laws and Regulations
1. Which Laws and Regulations Changed
As you are aware, on the basis of Financial Institution Letter 18-92, dated March 10, 1992, the recent Federal Deposit Insurance Corporation Improvement Act ("FDICIA") brings executive officers of insured state nonmember banks under certain lending limits that did not previously apply to such institutions. Specifically, section 306 of FDICIA provided that section 22(g) of the Federal Reserve Act shall apply to insured nonmember banks as if they were members of the Federal Reserve System ("Fed"). The effective date of section 306 is May 18, 1992.
Section 22(g) will make nonmember institutions subject to certain restrictions on loans to executive officers which are spelled out by provisions of Federal Reserve Board Regulation O ("Reg O"), 12 C.F.R. Part 215, that previously applied only to Fed members. Specifically, section 22(g) as applied to nonmember banks by section 306 of FDICIA requires the FDIC to amend its Rule 337, 12 C.F.R. § 337.3(a), in order to make nonmember banks subject to certain provisions of Reg O. The Board of Directors of the FDIC made the necessary amendment to section 337.3(a) on February 25, 1992, to become effective May 18, 1992. (See 57 Fed. Reg. 7647--7649, March 4, 1992).
The revisions to section 337.3(a) made nonmember banks subject to most of the Reg O provisions governing loans to executive officers, which are contained in 12 C.F.R. § 215.5.1 However, section 22(g)(4) provides that extensions of credit to an executive officer not otherwise specifically authorized by section 22(g) may be made "in an amount prescribed in a regulation of the bank's appropriate Federal banking agency." Thus, section 22(g)(4) requires the FDIC to prescribe by regulation the limits on loans to executive officers of state nonmember banks, other than those made for the purposes specifically enumerated by section 22(g) and its implementing regulations, 12 C.F.R. 215.5(c)(1) and (2). The FDIC has responded by making a further amendment of 12 C.F.R. 337.3. The proposed amendment was circulated as an attachment to Financial Institution Letter 18--92. (See also 57 Fed. Reg. 7670--7672, March 4, 1992.) The revisions to 12 C.F.R. 337.3(c) have now been issued as a final rule, in 57 Fed. Reg. 17847-17851, April 28, 1992, effective May 28, 1992.
2. The Substantive Impact of the Recent Changes Concerning Loans to Executive Officers of State Nonmember Banks
As a result of the foregoing changes, state nonmember banks must now look to Reg O, specifically 12 C.F.R. 215.5, and to 12 C.F.R. 337.3(c) to determine the limits that apply to loans made by such institutions to their executive officers, in addition to the more general limits on insider loans which are established by 12 C.F.R. § 215.4(c). Reg O (12 C.F.R. § 215.5(a)) provides that a bank may not extend credit to any of its executive officers except in the amounts, for the purposes, and upon the conditions specified in 12 C.F.R. 215.5(c) and (d). If the purpose of the loan is to finance the education of the executive officer's children the bank may extend credit in any amount, subject only to the conditions enumerated in § 215.5(d).2 Similarly, section 215.5(a)(2) provides that if the purpose of the loan is to finance the purchase, construction, maintenance, or improvement of a residence of the executive officer, and if the extension of credit is secured by a first lien on the residence and the residence is owned (or expected to be owned) by the executive officer, the bank may extend credit to the executive officer in any amount,3 subject only to the conditions enumerated in § 215.5(d). Finally, if an extension of credit by a nonmember bank to one of its executive officers is made for any purpose other than the education of the executive officer's children or the purchase, construction, maintenance, or improvement of the officer's residence, the transaction is governed by 12 C.F.R. § 337.3(c). This regulation provides that an insured nonmember bank may extend credit to any executive officer for any purpose not specified in Reg O §§ 215.5(c)(1) and (2) if the aggregate amount of such extensions of credit does not exceed the higher of 2.5 percent of the bank's capital and unimproved surplus or $25,000, but in no event more than $100,000.
In simple terms, the new regulations permit loans to be made by nonmember banks to executive officers in any amount up to the bank's aggregate Reg O lending limit for the education of the officer's children or the financing of the officer's residence. For any other purpose, the aggregate limit of all loans to any executive officer equals 2.5% of the bank's capital and unimpaired surplus, unless that figure is less than $25,000 or more than $100,000. In the former case, the limit would be $25,000. In the latter instance, the limit would be $100,000.
E. Application of Laws and Regulations to the Facts Presented
On the basis of the information which you presented in your letter, it appears that neither of the two existing extensions of credit to your executive officer could be made under the newly applicable regulations. Please note that this interpretation rests on my assumption, which may or may not be correct, that neither of the credits was extended for the specific purposes enumerated in Reg O, i.e. for the education of the officer's children or for the purchase, construction, maintenance, or improvement of the officer's residence. Assuming that both credits were extended for "other purposes," the aggregate limit for all "other purpose" loans to your officer would be $100,000.4
Your letter seems to assume that extensions of credit to executive officers are subject to a higher lending limit under the new regulations if such loans are secured by a first lien on the officer's residence. The language of § 215.5(c) is more restrictive than that. The higher lending limits for education and for residential financing are triggered by the purposes of the loans, not simply by the nature of the collateral. If the proceeds of a loan that is secured by a lien on an officer's residence are not used for the education of the officer's children or for the purchase, construction, maintenance, or improvement of the residence, the extension of credit is an "other purpose" loan, subject to the limitations specified by 12 C.F.R. § 337.3(c).
Therefore, if the extension of credit to your executive officer that is secured by a lien on his residence was made for any purpose other than the two which are specified by the regulations, this extension of credit in the amount of $468,000 must be aggregated with the other line of credit in the amount of $360,000 as "other purpose" loans, and both will become subject to the $100,000 aggregate limit set by § 337.3(c).5
F. Transitional Rule for Existing Loans
To the extent that the officer's existing loans exceed the newly applicable limits of § 337.3(c)(2), these extensions of credit will be subject to a transitional rule that is set forth in § 337.3(c)(3). Extensions of credit that are outstanding on May 28, 1992, and that would violate § 337.3(c)(2) if such extensions were made on or after that date, must be reduced in amount so that the extensions of credit comply with the limit set by § 337.3(c)(2) by May 28, 1993. Extensions of credit made prior to May 28, 1992, and having a maturity date prior to May 28, 1993, may be extended on terms that will bring the extension of credit into compliance with § 337.3(c)(2) by May 28, 1993. Any extension of credit made prior to May 28, 1992, that bears a specific maturity date of May 28, 1993 or later shall be repaid in accordance with its repayment schedule in existence on or before May 28, 1992. 12 C.F.R. § 337.3(c)(3). According to § 337.3(c)(4), if an institution is unable to bring all such pre-existing extensions of credit into compliance with § 337.3(c) by May 28, 1993, the appropriate Regional Director of the FDIC has the discretionary authority to grant not more than two additional one-year periods to come into compliance, if a bank demonstrates good cause for such further extensions.
Two caveats are in order with regard to the transitional rule. First, your letter seems to reflect a misunderstanding of the calendrical provisions of the regulation. Section 337.3(c)(3) permits your bank to extend or renew the officer's existing lines of credit after May 28, 1992 without requiring any reduction to come into compliance with the limit set by § 337.3(c)(2) until May 28, 1993. The regulatory language does not permit the bank to extend such non-complying lines of credit for a year from the date of a loan renewal which occurs after May 28, 1992, but only for a year from the effective date of the regulation. Secondly, you should be aware that any requested further extensions of non-complying lines of credit beyond May 28, 1993, are a matter of the Regional Director's discretion upon proper application by the bank, not a matter of right or entitlement. Under the language of the regulation, the burden of establishing good cause for granting such exceptions will fall on the bank. There is no basis for assuming that such extensions will be granted lightly.
The analysis, opinions, and conclusions contained in this letter reflect my best effort to respond to your questions on the basis of the limited information contained in your letter. These opinions and conclusions are not necessarily those of the Board of Directors of the FDIC, and accordingly nothing in this letter is binding upon the FDIC.
I hope that this letter is responsive to your questions and concerns. If you have any further questions, please do not hesitate to contact me.
1Nonmember institutions are still exempt from §§ 215.5(b), 215.5(c)(2), and 215.10. Go back to Text
2§ 215.5(d) requires that extensions of credit to executive officers: (1) be promptly reported to the bank's board of directors; (2) be made on substantially the same terms as those prevailing at the time for comparable transactions with other persons who are not employed by the bank; (3) not involve more than the normal risk of repayment or present other unfavorable features; (4) be preceded by the submission of a detailed current financial statement of the executive officer; and (5) be made subject to the condition in writing that the extension of credit will, at the option of the bank, become due and payable at any time that the officer is indebted to any other bank or banks in an aggregate amount greater than the amount specified for a category of credit in § 215.5(c) or in 12 C.F.R. § 337.3(c). Note that § 215.5 imposed "additional restrictions'' on loans to executive officers, so the language permitting extensions "in any amount" for the purposes specified in § 215.5(c)(1) and (2) is subject to the aggregate Reg O lending limit established by § 215.4(c), which is 15 percent of the bank's unimpaired capital and surplus in the case of loans not fully secured by readily marketable collateral, 12 C.F.R. § 215.2(g), not 5 percent as you seem to assume in your letter. Go back to Text
3Again, this language does not create an exception to the aggregate Reg O lending limit established by § 215.4(c). Go back to Text
4Based on the numbers contained in your letter, 2.5% of the capital and surplus of your bank would be $172,861.82. However, the applicable lending limit under 12 C.F.R. 337.3(c) is the higher of 2.5% of a bank's capital and surplus or $25,000, but in no event more than $100,000. Go back to Text
5If, on the other hand, I am incorrect in my assumption, and the line of credit that is secured by a lien on the officer's residence actually was made for the purpose of purchasing, constructing, maintaining, or improving the residence, then this line of credit is subject only to the general aggregate lending limit set forth in section 215.4(c) of Reg O. In such a case, this extension of credit in the amount of $468,000 would fall within the bank's Reg O lending limit of 15 percent of the bank's unimpaired capital and surplus. Go back to Text