4000 - Advisory Opinions
Classification of Loan as Insider Loan Does Not Cause Loan to Be in Violation of Regulation O
April 7, 1981
Pamela E. F. LeCren, Attorney
The following is in response to your March 27, 1981 letter requesting an opinion from the Legal Division regarding (1) whether or not the classification of an insider loan in and of itself causes the insider loan to be in violation of Federal Reserve Board Regulation O (12 C.F.R. Part 215) and (2) what if anything can a bank do in terms of a workout arrangement with regard to an insider loan when that loan has been classified.
According to your letter, *** has had a longstanding credit relationship with ***, a vegetable canning company. (Although your letter does not specifically state, we will presume that *** is a related interest of one of the bank's insiders.) During the bank's last examination an outstanding loan to *** was classified substandard. According to your letter, the subject loan when extended was made on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions with persons not employed by the bank nor subject to Regulation O. Furthermore, the loan did not present a more than normal risk of repayment or other unfavorable features.1
The bank did not renew the loan due to concerns regarding Regulation O. Rather than being renewed it was continued and a loan restructuring proposal reviewed. Part of the restructuring proposal called for the bank to lower its dollar exposure, maintenance of an existing accounts receivable and inventory formula, permitting temporary periods in which the loan would be "out" of formula, and substantial reduction of the loan over a set period of time.2 The bank's executive committee deferred action on the proposal pending an assessment of the implications of Regulation O.
The Legal Division is of the opinion that the mere classification of an insider loan does not indicate a violation of Regulation O (specifically § 215.4(a) on preferential lending) under the circumstances posed by your letter. Furthermore, Regulation O does not, in our opinion, require the bank to immediately call an insider loan that has been classified. If that loan is subsequently renewed or handled in any manner which creates a new extension of credit as that term is defined in § 215.3 of Regulation O, the bank may find itself in violation of § 215.4(a) if in so renewing or handling the loan the bank is not treating the insider loan as it would treat a similar non-insider loan. In short, if the bank in administering a workout of a distressed insider loan takes the same steps that it would take with reference to any other distressed loan of like type and amount and the insider loan is not given some preference in the manner in which it is handled, there would be no violation of § 215.4(a). Whether or not such a violation exists is a fact question and the bank should be prepared to substantiate any claim of non-preferential treatment. We are not now in a position to indicate whether or not the specific steps you propose in your letter to possibly be implemented in a workout of the loan would or would not present a problem under § 215.4(a). Assuming that the steps you outline conform to existing written or unwritten policies regarding loan workouts it is not likely that we would find a Regulation O violation.
1 The Legal Division has had little occasion to define the phrase "other unfavorable features". Suffice it to say that we are presently of the opinion that what is encompassed by that phrase must be determined on a case-by-case basis. We will assume that no unfavorable features were associated with the *** *** loan at the time of its extension i.e. it was a prudent business loan fully conforming in all respects with sound banking practice. Go back to Text
2 You indicated during a meeting in my office on March 25, 1981 that the loan has already been substantially reduced and that, as reflected in your letter, the bank had taken additional collateral on the loan prior to its classification. It is the bank's opinion that the bank would be adequately protected by the additional collateral during any period of time in which the loan was "out" of formula. Go back to Text