Each depositor insured to at least $250,000 per insured bank

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4000 - Advisory Opinions

This responds to your letter of December 10, 1993 to Pamela LeCren of this office concerning the FDIC's interpretation of Regulation O, 12 CFR §§ 215.3(a)(5) and 215.3(f).¹

You state that the chairman of a state chartered non-member bank sold real property to an unrelated third party who is not an insider or affiliate of the bank. The chairman financed a portion of the purchase price, evidenced by a promissory note and secured by a real estate mortgage. The bank wishes to make an extension of credit to the non-insider. You ask the following questions:

(1)  Assuming such an extension of credit met all of the bank's credit underwriting standards, was made on market terms, complied with applicable loan to value ratios, and that the chairman would have no further interest in the extension of credit either directly or indirectly, may the bank purchase the note and mortgage from the chairman?

(2)  If the answer is that the bank may not purchase the note and mortgage, may the bank originate a new loan to the non-insider which would be evidenced by the bank's own original note and mortgage, and which, in effect, would refinance the existing indebtedness to the bank's chairman?

(3)  Does 12 CFR § 215.3(f) prohibit the bank from making original financing to purchasers of assets from bank executive officers on market terms and in compliance with the bank's underwriting standards if such extensions of credit exceed $100,000 for any executive officer/seller?

The following first responds to your questions under the FDIC's interpretation of Regulation O in its present formulation. However, as you mention, the Federal Reserve Board has issued a proposed amendment to Regulation O (58 Fed. Reg. 47400 (Sept. 9, 1993)), which, if adopted in final form, could affect the FDIC's current interpretation of the rule, particularly as it applies to the issues you raise. With that in mind, we have also analyzed your questions in light of that proposal.

Concerning your first question, under the FDIC's present interpretation of 12 CFR § 215.3(a)(5), the bank's purchase of the note and mortgage from the chairman, i.e., a "discount of a promissory note", would constitute an extension of credit to the chairman, and, as such, have to meet Regulation O requirements.

As to your second question, under the FDIC's present interpretation of 12 CFR § 215.3(f), if the bank originates a new loan to the non-insider, that would constitute not only an extension of credit to the non-insider, but also to the chairman because the proceeds of the extension of credit to the non-insider will be transferred to the chairman. Such a transaction would have to meet Regulation O requirements.²

The answer to your third question is that under the FDIC's present interpretation of 12 CFR §§ 215.5(c) and 215.3(f), original financing to purchasers of assets from bank executive officers that in the aggregate would exceed $100,000 would be prohibited.

Regarding your first question, if the Federal Reserve's proposal is adopted, arguably the bank's purchase of the note and mortgage from the chairman would not constitute an extension of credit because the proposed rule does not treat transactions involving discounted promissory notes as extensions of credit.

Concerning your second question, because the Federal Reserve proposal excludes from the tangible economic benefit rule arms-length transactions to finance the bonafide purchase of property from an insider, the bank's origination of a new loan to the non-insider would not constitute an extension of credit to the chairman, and therefore would not have to meet Regulation O requirements.

As to your third question, under the Federal Reserve proposal insofar as original financing to a non-insider for the purpose of purchasing property from an insider is excluded from the operation of the tangible economic benefit rule as noted above, such financing, regardless of the amount, would not be prohibited.

We trust the foregoing responds to your inquiry. Thank you for writing to the FDIC.

¹Sections 215.3(a)(5) and 215.3(f) provide:
  (a)  An extension of credit is a making or renewal of any loan, a granting of a line of credit, or an extending of credit in any manner whatsoever, and includes:
  * * * * * *
  (5)  A discount of promissory notes, bills of exchange, conditional sales contracts, or similar paper, whether with or without recourse; but the acquisition of such paper by a member bank from another bank, without recourse, shall not be considered a discount by the member bank for the other bank;
  * * * * * *
  (f)  An extension of credit is considered made to a person covered by this part to the extent that the proceeds of the extension of credit are used for the tangible economic benefit of, or are transferred to, such a person.
  Regulation O was promulgated by the Federal Reserve Board and was made applicable to insured nonmember banks by section 18(j)(2) of the Federal Deposit Insurance Act (12 U.S.C. § 1828(j)(2)). Go back to Text

²The FDIC has had occasion to adopt a less strict interpretation of the tangible economic benefit rule. We have distinguished situations where third parties have used bank loans to purchase from a bank insider consumer goods and services from situations in which proceeds of a loan are used to pay the interest and/or principal owed by a covered person to the bank or where proceeds of a loan are used by the debtor to buy out the interest of a covered person in a venture. FDIC Interpretive Letter 89--36 (Oct. 30, 1989).
  This exception has been applied only to isolated consumer purchases where the loan was extended on an arms-length basis (e.g., the insider did not arrange the loan), the loan conformed to safe and sound banking practices, and the borrower was creditworthy. The rationale for this approach is that under Regulation O, such isolated consumer transactions should not be discouraged. Go back to Text

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