[Federal Register: August 23, 1996 (Volume 61, Number 165)]
[Proposed Rules]               
[Page 43486-43500]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]

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FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 362

RIN 3064-AA29

Activities and Investments of Insured State Banks

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Proposed rule.

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SUMMARY: The FDIC is proposing to amend its regulations governing the 
activities and investments of insured state banks. In general, subject 
to certain exceptions, insured state banks are prohibited from making 
equity investments of a type and in an amount that are not permissible 
for national banks or engaging as principal in activities of a type not 
permissible for national banks. The regulation requires banks to file 
with the FDIC their plan for the divestiture of any prohibited equity 
investments, establishes procedures regarding notices to the FDIC 
pertaining to excepted equity investments, delegates authority to act 
on notices, applications and divestiture plans, requires that banks 
provide certain information to the FDIC regarding existing insurance 
underwriting activities that the law allowed banks to continue, 
provides for application procedures to obtain consent to engage in 
otherwise impermissible activities, and establishes a number of 
exceptions to required consent. The proposed amendment substitutes a 
notice for an application when banks meet specified requirements for 
particular real estate, life insurance and annuity investment 
activities. If the FDIC does not object to the notice during the notice 
period, the bank may proceed with the planned investment activities.

DATES: Comments must be received by October 22, 1996.

ADDRESSES: Send comments to Jerry L. Langley, Executive Secretary, 
Federal Deposit Insurance Corporation, 550 17th Street N.W., 
Washington, D.C. 20429. Comments may be hand delivered to room F-402, 
1776 F Street N.W., Washington, D.C. on business days between 8:30 a.m. 
and 5 p.m. Comments may be sent through facsimile to: (202) 898-3838 or 
by the Internet to: comments@fdic.gov. Comments will be available for 
inspection at the FDIC Public Information Center, room 100, 801 17th 
Street, N.W., Washington, D.C. on business days between 9:00 a.m. and 
4:30 p.m.

FOR FURTHER INFORMATION CONTACT: Shirley K. Basse, Review Examiner,

[[Page 43487]]

(202) 898-6815, Division of Supervision, FDIC, 550 17th Street, N.W., 
Washington, D.C. 20429; Pamela E.F. LeCren, Senior Counsel, (202) 898- 
3730, Patrick J. McCarty, Counsel, (202) 898-8708 or Linda L. Stamp, 
Counsel, (202) 898-7310, Legal Division, FDIC, 550 17th Street, N.W., 
Washington, D.C. 20429.

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

   The collection of information contained in part 362 has been 
approved by the Office of Management and Budget under control number 
3064-0111 pursuant to section 3504(h) of the Paperwork Reduction Act 
(44 U.S.C. 3501 et seq.). Comments on the collection of information 
should be directed to the Office of Information and Regulatory Affairs, 
Office of Management and Budget, Washington, D.C. 20503, Attention: 
Desk officer for the Federal Deposit Insurance Corporation, with copies 
of such comments to be sent to Steven F. Hanft, Office of the Executive 
Secretary, room F-453, Federal Deposit Insurance Corporation, 550 17th 
Street, NW, Washington, D.C. 20429. The collection of information in 
this amended regulation is found in Sec. 362.4(c)(3)(vi) and 
Sec. 362.4(c)(3)(vii) and takes the form of a 60 day advance notice to 
be filed by an insured state bank that meets certain requirements and 
intends to: (1) invest, indirectly through a majority-owned subsidiary, 
in real estate investment activities; and/or (2) directly, or 
indirectly through a majority-owned subsidiary, invest in insurance 
products or annuity contracts. The information will allow the FDIC to 
properly discharge its responsibilities under section 24 of the Federal 
Deposit Insurance Corporation Act (12 U.S.C. 1831a). The information in 
the notices will be used by the FDIC to ensure compliance with the law, 
as part of the process of determining risk to the deposit insurance 
funds.

Notice to Indirectly Engage as Principal in Real Estate Investment 
Activities

   Number of Respondents: 250.
   Number of Responses Per Respondent: 1
   Total Annual Responses: 250
   Hours Per Response: 6
   Total Annual Burden Hours: 1,500

Notice to Directly or Indirectly Acquire or Retain Life Insurance 
Products or Annuity Contracts

   Number of Respondents: 60.
   Number of Responses Per Respondent: 1.
   Total Annual Responses: 60.
   Hours Per Response: 4.
   Total Annual Burden Hours: 240.

Background

   On December 19, 1991, the Federal Deposit Insurance Corporation 
Improvement Act of 1991 (FDICIA) (Pub. L. 102-242, 105 Stat. 2236) was 
signed into law. Section 303 of FDICIA added section 24 to the Federal 
Deposit Insurance Act (FDI Act), ``Activities of Insured State Banks'' 
(12 U.S.C. 1831a). With certain exceptions, section 24 of the Federal 
Deposit Insurance Act (FDI Act) limits the direct equity investments of 
state chartered insured banks to equity investments of a type and in an 
amount that are permissible for national banks. In addition, the 
statute prohibits an insured state bank from directly, or indirectly 
through a subsidiary, engaging as principal in any activity that is not 
permissible for a national bank unless the bank meets its capital 
requirements and the FDIC determines that the activity will not pose a 
significant risk to the deposit insurance fund. Section 24 provides 
that the FDIC may make such determinations by regulation or order. The 
statute requires that equity investments that do not conform to the new 
requirements must be divested no later than December 19, 1996 and 
requires that banks file certain notices with the FDIC concerning 
grandfathered investments.
   Part 362 of the FDIC's regulations (12 CFR part 362) implements the 
provisions of section 24 of the FDI Act. Among other things, part 362 
sets out application procedures whereby insured state banks may seek 
the FDIC's consent to engage in otherwise impermissible activities. The 
FDIC may impose such conditions and restrictions on the approval of any 
application as it deems necessary to prevent the conduct of the 
activity from posing a significant risk to the deposit insurance fund. 
Part 362 also provides for certain exceptions which allow adequately-
capitalized insured state banks to engage in named activities without 
prior consent as the FDIC has determined that engaging in the 
activities in question does not present a significant risk to the 
insurance fund.
   Between 1992 and April 30, 1996, the FDIC acted on 1156 
applications, notices and divestiture plans under section 24 either by 
action of the Board of Directors or by the Division of Supervision 
pursuant to delegated authority. The majority of the filings were 
notices and divestiture plans. The applications submitted for Board 
action have for the most part involved indirect equity interests in 
real estate (i.e. a majority-owned subsidiary holds or would hold the 
real estate investment) and direct investments in life insurance 
policies and annuities. The FDIC has evaluated these applications with 
a view toward developing a proper balance between minimizing risk to 
the deposit insurance funds and allowing state banks to engage in real 
estate, insurance and annuity investment activities where otherwise 
permitted under state law.
   Of the applications, notices and divestiture plans filed under 
section 24 and part 362, the Board acted on 34 applications to directly 
or indirectly initiate or continue as principal an impermissible 
activity, approving 31 applications. The Division of Supervision acted 
on a total of 1122 applications and/or notices which consisted of the 
following: 388 requests to directly or indirectly initiate or continue 
as principal in an impermissible activity; 460 notices regarding 
grandfathered investments in common or preferred stock or shares of an 
investment company (which includes plans for divestitures of the excess 
investments in the products); 272 divestiture plans regarding 
impermissible equity investments and impermissible activities; and 2 
requests to retain an equity investment in an insurance underwriting 
department. Of these filings, 5 applications were denied either in 
whole or in part.
   Based on the agency's experience with the applications to date, the 
FDIC proposes to amend part 362 to substitute a notice procedure for 
prior approval by application in the case of real estate investment, 
life insurance and annuity investment activities provided the banks 
meet certain conditions and restrictions. Under the proposed amendment, 
if the FDIC does not object to the notice within a maximum period of 90 
days (60 days initial period plus 30 day optional extension), the bank 
may proceed with its investment activity as planned. The agency's 
experience to date with real estate, insurance and annuity investment 
activities is discussed below along with a discussion of the risks 
associated with these types of investment activities. A detailed 
discussion of the proposed notice provisions follows.

Real Estate Investment Activities

   The circumstances under which national banks may hold equity 
investments in real estate are limited. If a particular real estate 
investment is permissible for a national bank, a state bank only needs 
to document that determination. If a particular real estate investment 
is not permissible for a national bank and a state bank wants to

[[Page 43488]]

engage in real estate investment activities (or continue to hold the 
real estate investment in the case of investments acquired before 
enactment of section 24 of the FDI Act), the bank must file an 
application with FDIC for consent. The FDIC may approve such 
applications if the investment is made through a majority-owned 
subsidiary, the institution is well capitalized and the FDIC determines 
that the activity does not pose a significant risk to the deposit 
insurance fund.
   The FDIC approved 63 of 66 applications from December 1992 through 
April 30, 1996 involving real estate investment activities. The FDIC 
denied one application, approved one in part, and one bank withdrew its 
application. The real estate investment applications generally have 
fallen into three categories: (1) Requests for consent to hold real 
estate at the subsidiary level while liquidating the property where the 
bank expects that liquidation will be completed later than December 19, 
1996; (2) requests for consent to continue to engage in real estate 
investment activity in a subsidiary, where such activities were 
initiated prior to enactment of section 24 of the FDI Act; and (3) 
requests for consent to initiate for the first time real estate 
investment activities through a majority-owned subsidiary.
   The approved applications have involved investments which have 
ranged from less than 1% to over 70% of the bank's Tier 1 capital. The 
majority of the investments, however, involved investments of less than 
10% of Tier 1 capital with only four applications involving investments 
exceeding 25% of Tier 1 capital. The applications filed with the FDIC 
have involved a range of real estate investments including holding 
residential properties, commercial properties, raw land, the 
development of both residential and commercial properties, and leasing 
of previously improved property. The applications FDIC approved 
included 21 residential properties, 29 commercial properties and 13 
applications covering a mix of commercial and residential properties. 
The assets of the institutions that submitted approved applications 
ranged from $15 million to $6.7 billion. The institutions which have 
been approved to continue or commence new real estate investment 
activity primarily have had composite ratings of 1 or 2 ratings under 
the Uniform Financial Institution Rating System (UFIRS). However, 2 
institutions were rated 3 and 2 institutions were rated 4. The 4-rated 
institutions submitted applications to continue an orderly divestiture 
of real estate investments after December 19, 1996. Of the approved 
applications, 6 were to conduct new real estate investment activities, 
while 54 were submitted to continue holding existing real estate or to 
hold existing real estate after December 19, 1996 in order to pursue an 
orderly liquidation. The remaining 3 approved applications asked for 
consent to continue existing holdings and conduct new real estate 
activities. One application was partially approved and partially 
denied. This application involved a bank that applied for consent to 
continue direct real estate activities and consent to continue indirect 
real estate investment activities through a subsidiary. The FDIC 
approved the application to continue the real estate investment 
activity through the subsidiary and denied the application for the bank 
to engage directly in real estate investment activities.
   In connection with the review of the above described applications, 
the FDIC undertook to determine what risk, if any, real estate 
investments pose to banks and ultimately to the deposit insurance 
funds. After reviewing, among other things, whether and to what extent 
real estate investments have played a role in the failure of 
institutions, the FDIC determined that real estate investments can pose 
significant risks, and that if such activities are to be permitted, 
prudential constraints should be imposed to control the various risks 
posed to both a financial institution and the deposit insurance fund. 
The results of that review are summarized below.

Risks of Real Estate Investment Activities

   Investments in real estate, at any stage of the development 
process, or even completed properties, generally can be characterized 
as 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 1980s and early 1990s, and the impact of that 
downturn on financial institutions, provides an illustration of the 
market risk presented by real estate investment activities. 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 activities can increase interest rate risk; 
optimum investment periods are typically long-term; real estate is 
relatively lacking in liquidity; and real estate is subject to 
specialized risks such as environmental liability. 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 the higher risk evident in real estate investments relative 
to more traditional banking activities, federally-chartered banks 
traditionally have been prohibited from acquiring or holding real 
estate solely for investment purposes. (Real estate investment 
activities remain permissible activities for subsidiaries of federally-
chartered thrift institutions.) State-chartered banks also were allowed 
to engage in real estate investment activities, if permitted by state 
law, without application to the FDIC until FDICIA required state-
chartered banks and their subsidiaries to obtain permission from the 
FDIC to engage in activities, including real estate investment 
activities, that are otherwise not permissible for national banks or 
subsidiaries of national banks.
   The function of an equity investor is to bear the economic risks of 
the venture. Economic risk is traditionally defined as the variability 
of returns on an investment. If a single investor undertakes a project 
alone, all the risk is borne by the investor. If investors participate 
in an investment through a vehicle such as corporate stock ownership, 
that stock grants its holders pro rata participation in control of that 
corporation, and in its profits and losses. If that corporation is 
liquidated, the investor has a residual interest in any unencumbered 
assets.
   An investor typically will have a required rate of return based on 
the historical track record of a particular company and/or type of 
investment project. Market participants face a general trade-off: The 
riskier the project, the higher the required rate of return. A key 
aspect of that trade-off is the notion that a riskier project will 
entail a higher probability of significant losses for the investor. 
Assessments of the degree of risk will depend on factors affecting 
future returns such as cyclical economic developments, technological 
advances, structural market changes, and the project's sensitivity to 
financial market changes.
   The actual return on an investment, however, will depend on 
developments beyond the investor's control. If the actual return is 
higher than the expected rate, the investor benefits. If the project 
falls short of expected returns, the investor suffers. At the extreme, 
an

[[Page 43489]]

investor can lose all or some of the original investment.
   Investments in real estate ventures follow this pattern. In fact, 
equity investments in commercial real estate have long been considered 
fairly risky because of the uncertainties in the income stream they 
generate. Both commercial and residential real estate markets in the 
post- World War II period have been marked by large cyclical swings. 
Two of those cyclical periods (the mid-1970s and the late 1980s through 
early 1990s) involved massive overbuilding of commercial projects. That 
overbuilding resulted in sharp declines in commercial property prices 
and serious losses to many investors. The historical performance of the 
industry clearly demonstrates considerable risk for investors.
   If an investment is made solely using the funds of an investor, the 
investor bears all the risk. However, if the project is partially 
financed by debt, the risks are shared with the lender. Nonetheless, 
the equity investor typically still bears the bulk of the variation in 
the risk and rewards of an investment. As a rule, the lender is 
compensated at an agreed amount (or formula in the case of a variable 
rate loan). The lender is paid--both interest and principal--before the 
equity investor/borrower receives any rewards or return of investment. 
Thus, any downside outcome is borne first by the equity investor. In 
properly underwritten loan arrangements the lender bears the economic 
risk of significant losses only in the case of significant negative 
outcomes. Since the legal priority of the debt holder is higher in a 
liquidation or bankruptcy than that of the equity holder, the debt 
holders are hurt if the investment entity has very limited resources. 
Of course, the borrower/equity investor receives all of the up-side 
potential returns from the investment.
   While a leveraged investor has less of his/her own funds at stake, 
the use of borrowed funds to finance an investment greatly magnifies 
the variability of the returns to the equity investor. That is to say, 
leverage increases the risks involved. For instance, a small decline in 
income in an unleveraged investment may only mean less positive 
returns; to the leveraged investor, it may mean out of pocket losses, 
as debt service may have already absorbed any income generated by the 
project. Conversely, a small increase in generated income may just 
moderately increase the rate of return on an all equity investment but 
have a major positive effect on the highly leveraged investor.
   The fact that most commercial real estate investments are highly 
leveraged also affects overall market volatility. For instance, high 
interest rates will lower the expected rate of return for highly 
leveraged investments which will, in turn, lower effective demand. 
Thus, prices offered for commercial real estate during periods of high 
interest rates typically are lowered. For example, to the extent that 
there was a ``credit crunch'' for commercial real estate in the early 
1990s and lenders were unwilling to extend credit, diminished effective 
demand for a property could have resulted in the elimination of a broad 
class of potential investors, rather than simply a lower price being 
bid.
   The economic viability of any investment in real estate ultimately 
depends on the economic demand for the services it provides. Thus, 
fluctuations in the economy in general are translated into 
uncertainties in the underlying economics of most real estate 
investments. National economic trends, regional developments, and even 
local economic developments will affect the volatility of returns. A 
traditional problem for real estate investors in that regard is that, 
when the economy as a whole reaches capacity during an economic 
expansion, they are one of the sectors seriously affected by the 
resulting run-up in interest rates.
   Much of the uncertainty associated with real estate investment, 
however, comes from the nature of the production itself--how new supply 
is brought to market. Investments in the construction of real estate 
typically have a long gestation period; this long planning period is 
especially characteristic of large commercial development projects. 
Given the traditional cyclicality of the economy and financial markets, 
the economic prospects for an investment can change radically during 
that period, altering timing and terms of transactions.
   Moreover, real estate investors also typically have trouble getting 
full information on current market conditions. Unlike highly organized 
markets where participants can easily obtain data on market 
developments such as price and supply considerations, information in 
the commercial real estate market is often difficult, or impossible, to 
obtain. Also inherent in the investment process for commercial real 
estate is the fact that the market is relatively illiquid--particularly 
for very large projects. Thus, instead of having numerous frequent 
transactions that incorporate the latest market information and ensure 
that prices reflect true economic value, markets can be thin and the 
timing of a sale or rental contract can affect the value of the 
underlying investments.
   In addition to the inherent illiquidity of commercial real estate 
markets, transactions often are ``private deals'' in which the major 
parameters of the investment are not available to the public in general 
and, in particular, to rival developers. For instance, the costs of 
construction are a private transaction between the developer and his 
contractor. Likewise, gauging selling prices or rental income is 
difficult since: (1) There are no statistical data on transaction 
prices available as there are for single-family structures and (2) even 
if there were data available, it would be impossible to account for the 
many creative financing techniques involved in commercial sales and in 
rental agreements (e.g., tenant improvements and rent discounting).
   Because of imperfect market information and the length of the 
production process, prices of existing structures are often 
artificially bid up in market upswings. That is, short-term shortages 
fuel speculative price increases. Speculative price increases (whether 
it be for raw land, developed construction sites, or completed 
buildings) typically encourage even more construction to take place, 
leading to additional future overbuilding relative to underlying 
demand.
   In addition to the inherent cyclicality of real estate markets, 
several underlying factors create additional uncertainties in the 
investment process. Changes in tax laws will affect the profitability 
of real estate investments. For example, tax changes were a major 
consideration in the 1980s, but changes in depreciation allowances and 
in tax rates have been commonplace in the post-World War II era.
   Another uncertainty is the effect of other governmental actions, 
especially in the area of regulations. A prime example is Federal 
mandates requiring clean-up of existing environmental hazards that 
imposed unexpected costs on investors at the time they were passed. 
Similar uncertainties result from state and local laws that effect real 
estate and how it can be developed. For instance, changes in 
environmental restrictions of new construction can add unexpected costs 
to a project or even bar its intended use. Similarly, a zoning change 
can positively or negatively affect investment prospects unexpectedly. 
All of these factors add to the uncertainty of returns and thereby 
increase the risk of the investment.
   Two other considerations often play into increasing risks in real 
estate investment. First, the efficient execution of a real estate 
investment usually

[[Page 43490]]

requires a ``hands on'' approach by an experienced manager. This level 
of involvement is especially true of a construction project where 
developers have to deal with a wide variety of problems ranging from 
governmental approvals to sub-contractors and changing commodity 
markets. For an investment in developed real estate, maintenance 
problems, replacing lost tenants, and adjusting rents to retain tenants 
all must be addressed in an environment of ever changing market 
conditions.
   Many equity investors solve these problems by ``hiring'' someone 
else to manage the investment. The experience of the 1980s shows that 
there are specific risks involved in separating ownership from 
management. For instance, many tax-oriented investors in the early 
1980s arguably knew little about the basic economics of the investments 
they were undertaking. In a perfect world, ``passive'' investment would 
work just as efficiently as direct, active investment. In reality, 
investment outcomes are likely to be more uncertain for equity 
investors when someone else is making decisions that affect the 
ultimate return.
   Finally, an issue that plays into long-run risks in real estate 
investment is the fact that real estate markets--especially commercial 
real estate markets--are affected by both national and local 
developments. Even if knowledge were more widespread within local real 
estate markets, it is difficult to track all the relevant parameters of 
the investment decision geographically. Most commercial real estate 
investments have both a local and national component because firms 
demanding commercial floor space are typically geographically mobile. 
For example, the developer of an industrial park would have to be 
concerned about how existing and future developments located in close 
proximity to the project might affect the returns on the investment. 
However, operating income and the ability to attract and keep tenants 
also can be affected by market conditions around the country.
   A financial institution--like any other investor--faces substantial 
risks when it takes an equity position in a real estate venture. If the 
investment were a direct, all-equity venture, the institution would 
bear all of the substantial economic risks in this highly-cyclical 
industry. If the entity making the investment is highly leveraged, a 
completely new set of financial risks are incurred. A poor investment 
outcome can quickly wipe out the leveraged equity investment. Finally, 
the risks also can easily be magnified if--because of the form of 
investment or debt instrument--the equity investor is separated from 
the day-to-day economic and financial decisions affecting the prospects 
for the venture.

Conditions Imposed in Connection With Approvals of Real Estate 
Applications

   In view of the risks identified with real estate investment 
activities, the statutory requirement that approval should not be 
granted unless the FDIC determines that the activity does not pose a 
significant risk to the fund, and the FDIC's loss experience relating 
to institutions that failed either partly or principally because of 
real estate investment activity, staff determined that a number of 
prudential constraints may be necessary to control the risk to the 
individual bank and to the deposit insurance fund before concluding 
that real estate investment activities do not present a significant 
risk to the fund.
   To date the FDIC has evaluated a number of factors when acting on 
applications for consent to engage in real estate investment 
activities. Where appropriate, the FDIC has fashioned conditions 
designed to address potential risks that have been identified in the 
context of a given application. In evaluating an equity real estate 
investment activity application the FDIC has usually considered the 
type of proposed real estate investment activity to determine if the 
activity is unsuitable for an insured depository institution. The FDIC 
also has reviewed the proposed subsidiary structure and its management 
policies and practices to determine if a bank is adequately protected 
from litigation risk and analyzed capital adequacy to ensure that a 
bank first devotes sufficient capital to its more traditional banking 
activities. In conjunction with this evaluation, the FDIC has evaluated 
capital adequacy with respect to a bank's ``consolidated'' and ``bank 
only'' leverage and risk-based capital ratios. In doing so, the FDIC 
excluded all investments in real estate investment subsidiaries from 
capital in the ``bank only'' capital calculation. The FDIC has 
evaluated limitations on investment in a subsidiary engaging in real 
estate investment activities to assure that the maximum risk exposure 
is nominal; evaluated policies relating to extensions of credit to 
third parties for subsidiary-related transactions to determine if they 
protect the bank from concentrations of risk; and reviewed policies on 
engaging in transactions in which insiders are involved to determine if 
they protect the bank from potential insider abuse. In addition, the 
FDIC has reviewed 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 to determine if they prevent undesirable tying 
relationships and to determine if they are adequate to ensure that 
sound credit underwriting is maintained. Finally, the FDIC has reviewed 
and evaluated management's particular expertise relative to the 
activities in question.
   In every instance in which the FDIC has approved an application to 
conduct a real estate investment activity a number of conditions have 
been imposed for prudential reasons due to the unpredictability of 
returns and other risks which are inherent in real estate investment 
activities as well as to mitigate potential insider conflicts of 
interest and to reduce risk to the insurance fund. In short, the FDIC 
has determined on a case-by-case basis that the conduct of certain real 
estate investment activities by a majority-owned subsidiary of an 
insured state bank will not present a significant risk to the deposit 
insurance fund provided certain conditions are observed. The conditions 
which have been imposed as well as the purpose intended to be achieved 
by imposing the conditions are discussed below. Not every condition has 
been imposed in connection with each approval. The conditions have been 
imposed on a case-by-case basis in light of the particular facts.

Capital

   Most of the approval orders have a condition concerning capital. 
Often the statutory requirement to meet and maintain adequate capital 
is restated. In some instances, banks applying to conduct real estate 
investment activities that entail more inherent risk, such as 
undertaking a development project, have been required to maintain 
capital that equals or exceeds the level required for ``well 
capitalized'' institutions as defined in Part 325 after deducting the 
bank's investment in any subsidiaries engaged in real estate investment 
activities. The capital deduction has not been imposed in most 
approvals of applications when the bank is liquidating existing real 
estate investments. Indirect real estate investment activities for 
purposes of the orders typically has been defined to include equity 
interests in the real estate subsidiary, debt obligations of the 
subsidiary held by the bank, bank guarantees of debt obligations issued 
by the subsidiary, and extensions of credit or commitments of credit to 
any third party for the purpose of making a direct investment in the 
subsidiary or making

[[Page 43491]]

an investment in any investment in which the subsidiary has an 
interest. The purpose of requiring the bank to be well-capitalized on a 
bank-only basis is to ensure the continued viability of the bank, if 
the investment in the subsidiary were to be lost. Such a calculation 
serves as an ``acid test'' of the worst-case impact a real estate 
investment activity would have on an institution's capital position in 
the event that an institution's entire real estate-related investment 
were to be dissipated.
   In instances in which the capital deduction has been imposed the 
bank has been required to take the deduction for call report purposes 
including for purposes of prompt corrective action and risk based 
premiums, except that the deduction is not taken when determining 
whether the bank is critically under-capitalized.

Transactions with Affiliates

   Another condition that FDIC frequently has imposed requires that 
transactions between a bank and its real estate subsidiary comply with 
the restrictions that would apply under sections 23A and 23B of the 
Federal Reserve Act (12 U.S.C. 371c and 371c-1) as between a bank and 
its affiliate. Among other things, section 23A requires that a bank 
limit its covered transactions with affiliates to no more than 10% of 
the bank's capital for one affiliate and 20% of its capital for all 
affiliates. For the purposes of 23A, capital and surplus is defined as 
Tier 1 and Tier 2 capital included in an institution's risk-based 
capital under the capital guidelines of the appropriate Federal banking 
agency, based on the institution's most recent consolidated Report of 
Condition and Income filed under 12 U.S.C. 1817(a)(3) and the balance 
of an institution's allowance for loan and lease losses not included in 
its Tier 2 capital for purposes of the calculation of risk-based 
capital by the appropriate Federal banking agency. The effect of the 
section 23A restrictions is to also prohibit the bank and its 
subsidiary from purchasing low-quality assets from each other unless a 
commitment was made to purchase the asset before its acquisition by the 
affiliate, pursuant to an independent credit evaluation.
   Section 23B generally requires that covered transactions between a 
bank and its affiliate (including the purchase of services or assets 
from an affiliate under contract) are entered into under terms that are 
substantially the same, or at least as favorable to the bank as those 
prevailing at the time for comparable transactions with or involving 
other nonaffiliated companies. Section 23B also generally requires that 
affiliates not purchase as fiduciary any securities or other assets 
from any affiliate unless such purchase is permitted under the 
instrument creating the fiduciary relationship, by court order or by 
law. In addition, section 23B prohibits affiliates from publishing any 
advertisement or entering into any agreement stating or suggesting that 
the bank is in any way responsible for the obligations of its 
affiliates.
   FDIC has imposed the above restrictions to keep the transactions 
between the bank and the real estate investment subsidiary at arm's 
length and to limit the bank's investment in the subsidiary. In 
instances in which an application has involved continuing investment in 
a subsidiary that at the time of application exceeds these limits, the 
FDIC has usually modified the limitation to allow the excess investment 
while imposing the amount limits on future transactions. The FDIC often 
has made an exception for the collateral and amount limitations imposed 
on loans from the bank to facilitate the sale of the real estate 
investments held by the subsidiary, provided that the loans are 
consistent with safe and sound banking practices, do not present 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.

Real Estate Subsidiary Structure and Operations

   There are numerous benefits which flow from ensuring that a parent 
and its subsidiary maintain a separate corporate existence. Such 
separation insulates banks and the deposit insurance fund from undue 
risk and potential liability stemming from litigation. To protect 
against ``piercing the corporate veil'' between the subsidiary and 
parent, thus mitigating litigation risks, the FDIC usually has required 
that the bank conduct real estate investment activities in a majority-
owned subsidiary which is adequately capitalized; is physically 
separate and distinct in its operations from the operations of the 
bank; maintains separate accounting and other corporate records; 
observes corporate formalities such as holding separate board of 
directors' meetings; 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; contracts 
with the bank for any service on terms and conditions comparable to 
those available to or from independent entities; and conducts business 
pursuant to separate policies and procedures designed to inform 
customers and prospective customers of the subsidiary that it 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. The FDIC has recognized that requiring total separation of 
the management of the subsidiary from the bank's management could 
enhance the corporate separateness of the subsidiary. However, in 
keeping with the FDIC's review and analysis of the downside risks real 
estate investments pose when separating ownership from management, the 
Board typically has required only a minimum of one independent 
director. In addition, FDIC has considered the presence of one or more 
outside directors to be a helpful deterrent to potential insider abuse, 
an enhancement to diversity and expertise and an opportunity to augment 
decision-making with a counterbalancing perspective.

Investment Limits

   In order to maintain proper diversification and to effectively 
control the concentration of credit and investment risk, FDIC has 
required banks to identify and aggregate loans made to third parties 
for the purpose of investment in real estate held by the bank's 
subsidiary with the bank's own real estate investment activities and 
included that figure in the bank's investment in the real estate 
subsidiary. Generally, the FDIC has limited the amount of real estate 
investment activity to the amount contemplated in the business plan 
submitted with the application and requires the bank to notify the FDIC 
in the event of any significant change in facts or circumstances. This 
condition is designed to limit the exposure from the real estate 
investment activity and allow the FDIC to evaluate any additional real 
estate investment activity when contemplated by the bank.

Lending to Third Parties

   The FDIC has conditioned approvals of applications to conduct real 
estate investment activity by including limits on the extension of 
credit to third parties for a direct investment in a bank subsidiary 
engaged in real estate investment activity to further limit the 
exposure of the state bank to real estate investment.

[[Page 43492]]

Insiders

   Limiting buying and selling by bank insiders also has been imposed 
as a condition to the approval of applications to conduct real estate 
investment activity. These conditions generally require that the bank's 
subsidiary not be permitted to engage directly or indirectly with 
insiders in transactions involving the subsidiary's real estate 
investment activities without the prior written consent of the FDIC. 
These restrictions are in addition to the constraints on lending to 
insiders imposed by Regulation O (12 CFR 337.3). The bank is expected 
to identify conflicts of interest and their resolution by the Board 
should be documented.

Fiduciary and Trust Restrictions

   In order to maintain safe and sound underwriting standards, to 
reduce or preclude the potential for breaches of fiduciary duties, and 
to protect the bank and the deposit insurance fund, FDIC has imposed 
one or more of the following conditions: (1) That the bank not 
condition any loan on the purchase or rental of real estate from any 
subsidiary engaged in real estate investment activities; and (2) that 
the bank not purchase real estate from the subsidiary in its capacity 
as a trustee for any trust, unless expressly authorized by the trust 
instrument, court order, or state law.
   On occasion, FDIC has imposed a condition that any potential 
conflict of interest be identified, appropriately resolved, if 
possible, and approved by the bank's board of directors prior to the 
consummation of any transaction. This condition is considered a 
reasonable approach to avoiding the risk of loss from conflicts of 
interest while providing the bank with flexibility in resolving any 
such issue.

Life Insurance Investments

   The Office of the Comptroller of the Currency (OCC) has established 
certain general guidelines for national banks to use in determining 
whether they may legally purchase a particular insurance product. These 
guidelines are contained in an OCC Banking Circular (BC 249), issued 
May 9, 1991. That circular indicates that the authority for national 
banks to purchase and hold an interest in life insurance is found in 12 
U.S.C. section 24 (seventh) which permits national banks to exercise 
all such incidental powers as shall be necessary to carry on the 
business of banking.1 The circular indicates that the OCC has 
further delineated the scope of that authority through regulations, 
interpretive rulings, and letters addressing the use of life insurance 
for purposes incidental to banking. Although the circular leaves open 
the possibility that there may be other uses of life insurance that are 
``incidental to banking'' (the circular says the purposes ``include'' 
those described in the circular), the circular clearly indicates that 
there is no authority under 12 U.S.C. 24 (seventh) for national banks 
to purchase life insurance for their own account as an investment. If 
an insured state bank wishes to purchase an insurance product that does 
not meet the guidelines contained in BC 249, that purchase is 
considered to be an activity that is not permissible for a national 
bank within the meaning of part 362. The purchase by the state bank 
would therefore not be permissible unless the bank meets its minimum 
capital requirements and the FDIC determines that there is no 
significant risk to the deposit insurance funds. Under current 
regulations the bank must make application for consent to make or 
retain the investment and the FDIC then makes a determination based on 
the facts and circumstances of the particular case.
---------------------------------------------------------------------------

   \1\ In one instance the circular cites to 12 U.S.C. section 24 
(fifth) which authorizes national banks to elect or appoint 
directors and to employ bank officials.
---------------------------------------------------------------------------

   The BC 249 provides two tests for national banks to use in 
determining whether they may legally purchase a particular insurance 
product. Test A relates to key-person life insurance. Under Test A the 
insurance coverage must closely approximate the risk of loss. Test B 
relates to life insurance as an employee benefit and provides that, 
based upon reasonable actuarial benefit and financial assumptions, the 
present value of the projected cash flow from the policy (insurance 
proceeds) must not substantially exceed the present value of the 
projected cost of the associated compensation or benefit program 
(employee benefits). Insurance as an estate planning benefit is 
specifically recognized, but only as part of a reasonable compensation 
agreement or benefit plan.
   Insurance proceeds include projected death benefits, loans against 
the policy before the death of the insured to fund retirement payments, 
and any other withdrawals by the bank. The projected cost of employee 
benefits includes the bank's actual cost associated with the insurance 
policy (the periodic mortality charges, loads, surrender charges, 
administrative charges and other fees that are expected to be assessed 
against the policy's cash surrender value during the term of the 
policy) plus the projected amount of any retirement or other deferred 
benefit payments that are expected to be paid out to employees or their 
beneficiaries.
   It is well established that certain types of insurance products are 
actually ``securities'' under the Federal securities laws. Certain life 
insurance policies--common names include universal life or variable 
life--are ``securities.'' Banks may have to hold these investments 
through a subsidiary, rather than directly. If the life insurance 
policy in question is considered to be a security, and it does not 
qualify under either Test A or Test B of OCC BC 249, then the life 
insurance policy must be held through a subsidiary of the bank as 
required under section 24 and part 362.

Risks Associated With Life Insurance Investments

   A bank holding a life insurance contract as an investment is 
exposed to a variety of risks, most of which are similar in nature to 
the types of risks banks are exposed to on both sides of the balance 
sheet: credit risks, liquidity risks, and interest rate risks. In 
addition, there is actuarial risk inherent in holding a life insurance 
policy that exposes banks to different risks than are usual in the 
banking industry. Unless the issuing company becomes insolvent, a life 
insurance policy investment gives a bank the potential for low returns 
over the life of the investment, rather than loss of principal.
   Banks purchase various forms of life insurance contracts as either 
key-person protection for the bank or as a compensation benefit for the 
employee. In certain instances, the policies provide a benefit to 
executive officers who are also majority stockholders in the form of an 
estate planning tool. Many of these policies require large single 
premiums or periodic premiums of a substantial amount. These premiums 
may result in the build-up of significant cash surrender or investment 
values that cannot be easily liquidated without adverse tax 
consequences.
   Since life insurance products represent an unsecured obligation of 
the issuing company, there is some credit risk involved in these 
products. As the companies are regulated by state insurance 
commissioners without any federal regulatory oversight, there will be 
some variation in the strictness of the regulatory regimes from state 
to state. If a state insurance commissioner declares a firm to be 
insolvent, the holders may receive payments from (1) other insurance 
companies (the industry has, in some past events, supported the 
policies of failed firms in order to promote investor confidence.); (2) 
liquidation of the issuer's assets and sale of the firm; (3) lawsuits; 
and/or (4)

[[Page 43493]]

state insurance funds. The existence, structure, and coverage provided 
by these funds varies, however, they typically are not pre-funded and 
may ultimately be unable to provide the required support.
   Unlike other types of investments, no secondary market for 
insurance products exists, making some liquidity risk inherent in these 
investments. Cashing out the policy can be costly because of the tax 
consequences. The illiquidity of the policies may be mitigated by two 
factors: (1) Many policies have provisions that permit the holder of 
the policy to borrow against the current cash value at a minimal 
interest rate, and (2) a bank moving toward insolvency holding an 
insurance policy will probably be able to offset other losses with the 
taxable income that is realized by cashing out the policy.
   The interest rate risks inherent in an insurance policy will vary 
with each insurance contract. The build-up of cash value depends on the 
performance of the underlying investment portfolio. Individual 
portfolios often have different interest rate risk characteristics. 
Insurance companies may write whole life policies with a single 
interest rate applied to the cash buildup, making the interest rate 
risk very high. Other policies may give the insurance company 
flexibility in determining the applicable future interest rates. These 
policies present actuarial risks because the maturity date of an 
insurance policy held until the death benefit is paid is unknown at the 
time the investor purchases the policy. Prior to the death of the 
insured party, comparing the investment returns provided by such a 
policy with alternative investments requires the calculation of an 
actuarial estimate of the life expectancy of the insured party. Should 
the insured die prior to his/her estimated life expectancy, the 
beneficiary reaps an investment windfall. However, if the insured's 
life exceeds the actuarially determined life expectancy, the ultimate 
performance of the investment will suffer (relative to the returns that 
would have been realized from alternative investments undertaken at the 
time). Insurance companies control the variance of results by applying 
actuarial principles to large populations of insured individuals. A 
bank holding policies on a handful of former employees cannot control 
the variability of the returns.
   Various supervisory concerns can arise when banks invest in 
insurance policies. These concerns include potential violations of laws 
and regulations, a less than adequate rate of return, the illiquid 
nature of the investment, the potential for substantial tax 
obligations, and concentration of investment risk.
   The FDIC scrutinizes bank purchases of life insurance for three 
particular potential violations other than section 24. Where a bank 
purchases split-dollar insurance to provide a fringe benefit to an 
executive officer of a bank, the executive must either reimburse the 
bank or report as additional taxable income the economic value of the 
benefits (as determined by the IRS). Otherwise, a violation of Federal 
Reserve Board Regulation O may occur (12 CFR part 215).
   When a bank's holding company or other affiliate is a beneficiary 
of a life insurance policy purchased by a bank, the holding company 
must pay for its beneficial share of the premiums and periodic costs of 
the policy in order to comply with sections 23A and 23B of the Federal 
Reserve Act (12 U.S.C. 371c and 371c-1). If, net of such 
reimbursements, the present value of projected insurance proceeds 
substantially exceeds the present value of employee benefits, the 
insurance arrangement will fail to meet the BC 249 standards.
   For those insurance arrangements that will provide compensation or 
other benefits to employees or their beneficiaries, the amount of such 
expected benefits must be quantified and not exceed reasonable 
compensation levels when combined with other forms of compensation 
provided to those employees. Section 39 of the FDI Act prohibits 
excessive compensation as an unsafe or unsound act.2
---------------------------------------------------------------------------

    2  12 U.S.C. 1831p-1(c).
---------------------------------------------------------------------------

   The propriety of investing large sums in a policy that, over time, 
may provide a less than adequate rate of return is a consideration. 
However, these assets should be viewed in the context of the bank's 
overall asset and liability structure and not viewed in isolation to 
determine if they pose a significant risk to the fund.
   Supervisory concern may exist over the long-term, illiquid nature 
of those insurance policies that cannot realistically be liquidated at 
the option of the bank without incurring sizeable surrender charges and 
adverse tax consequences. Liquidity should not be judged in isolation 
from other assets of the bank. Liquidity concerns may be mitigated if 
the bank has the ability to borrow against the policies without 
incurring adverse tax consequences or surrender charges.
   Banks generally do not pay federal income taxes on the increases in 
the cash value of an insurance policy as long as the bank holds the 
policy until the death of the insured. As a result, banks that intend 
to hold the policy until the insured's death normally do not record any 
deferred tax liability for accounting purposes. However, should the 
bank surrender the policy prior to the insured's death, the bank would 
incur taxable income if the cash value received exceeded the amount of 
premium paid. The cash value build-up over time could result in sizable 
income taxes should the policy be surrendered early.
   Due to the liquidity, credit, and tax considerations, unduly large 
concentrations in investments in life insurance policies could result 
if a bank does not adopt prudent constraints on the amount of its 
exposures.

Life Insurance Applications

   As of June 4, 1996, the FDIC had acted upon 106 applications by 
insured state banks for consent to continue to hold investments in life 
insurance policies. 101 of these applications involved policies 
acquired prior the effective date of the activities restrictions of 
section 24 of the FDI Act (December 19, 1992). Four banks had policies 
that were acquired after December 19, 1992, and one bank had a 
combination of policies acquired before and after the effective date. 
Of the 106 applications, almost two thirds (67) of the institutions 
were operating with a UFIRS composite rating of 2. Thirty (30) 
applications were from institutions that had composite ratings of 1, 
seven with a rating of 3, and two had a UFIRS composite rating of 4. 
None were 5 rated.
   The insurance policies held by any one bank ranged from less than 
1.0% of Tier 1 capital to 52% of Tier 1 capital. Over ninety percent 
(88 of 106) of the banks held investments totaling less than 30% of 
Tier 1 capital. However, 63 of the 106 applications involved an 
aggregate investment that did not exceed 20% of Tier 1 capital with the 
majority (45 of 63) of those investments representing less than 10% of 
Tier 1 capital.
   All of the applications were approved. The actions were taken 
either by the FDIC Board of Directors or by the Director of the 
Division of Supervision pursuant to delegated authority.
   The FDIC required all of the banks receiving approval to adhere to 
specific conditions deemed necessary to limit the risk to the banks and 
thus the insurance fund. Among the conditions were: (1) that the bank 
continue to meet applicable capital standards, (2) that the

[[Page 43494]]

bank shall notify the FDIC of any significant changes in the facts or 
circumstances on which the approval was based, (3) that the bank may 
not modify the terms or conditions of the policies (except for 
redemption of same) without the prior written consent of the FDIC, (4) 
that the bank may not acquire any additional life insurance policies 
without prior written consent of the FDIC, (5) that the bank must 
reduce the cash surrender value of the policies, (6) that the bank must 
receive approval of its applicable state authority, (7) that the bank 
may not pay additional annual premiums without consent of the FDIC, and 
(8) that the timing and amounts of the holding company's proportionate 
share of overall insurance costs will be made in a manner which will 
preclude any violations of section 23A or 23B of the Federal Reserve 
Act. Some or all of these conditions were imposed where the facts 
warranted the imposition of the particular condition in order to 
protect the deposit insurance fund from risk.

Annuity Contracts

   Interpretative guidance issued by the OCC states that national 
banks are not permitted to invest in annuities for their own account. 
If an insured state bank wishes to purchase an annuity contract, the 
purchase is considered an activity that is not permissible for a 
national bank and section 24 of the FDI Act applies. The purchase by 
the state bank would therefore not be permissible unless the bank meets 
it minimum capital requirements and the FDIC determines that there is 
no significant risk to the deposit insurance funds.
   As noted above, certain types of life insurance policies and 
annuity contracts are considered to be ``securities'' under the federal 
securities laws. If the annuity contract in question is considered to 
be a security, and this would apply to variable rate annuity contracts, 
it must be held through a subsidiary of the bank as required under 
section 24 and part 362. Fixed rate annuity contracts are considered to 
be insurance products and may be held directly by the bank.
   A bank holding annuity contracts in connection with a deferred 
compensation plan is exposed to a variety of risks, most of which are 
similar in nature to the types of risks banks are exposed when 
investing in life insurance policies: credit risks, liquidity risks, 
and interest rate risks.
   Annuity contracts are similar to certificates of deposit in that 
the investor places money with an institution, such as an insurance 
company, in the expectation of the return of the investment plus 
earnings at a specified later date or on a specified schedule. Some 
annuities provide that the investor may select a lifetime payout, which 
provides a fixed income until the death of the annuitant. However, 
unlike a bank certificate of deposit, an annuity is uninsured, creating 
credit risk. An investor is not subject to the risk of loss of 
principal through market fluctuations, but the investor has credit risk 
based on the solvency of the issuing entity.
   The lack of a secondary market for annuities gives rise to 
liquidity risk. Such investments are generally long term, subject to 
varying early withdrawal penalties and early redemption may cause a 
loss of tax deferral advantages.
   Interest rate risk arises from fixed rate annuities, particularly 
in light of the long term nature of these contracts. Most insurance 
companies offer variable rate arrangements to mitigate interest rate 
risk. However, the issuing company generally determines interest rates 
on variable rate contracts and may not use a common index. For this 
reason, future yields are uncertain and likely to be lower than other 
available types of investments. However, interest rate floors may 
mitigate this risk. We see the same interest rate structure in certain 
types of life insurance policies wherein the return is dependent on an 
interest payment calculated on the cash surrender value of the policy.
   Various supervisory concerns similar to those associated with 
investments in insurance policies arise when banks invest in annuity 
contracts. They include potential violations of laws and regulations, 
less than adequate rate of return, the illiquidity of the investments, 
and concentration of investment risks. For those annuities that will 
provide compensation or other benefits to employees or their 
beneficiaries, the amount of such expected benefits must be quantified 
and not exceed reasonable compensation levels when combined with other 
forms of compensation provided to those employees. As stated earlier, 
section 39 of the FDI Act prohibits excessive compensation as an unsafe 
or unsound act.3
---------------------------------------------------------------------------

   \3\ 12 U.S.C. 1831p-1(c).
---------------------------------------------------------------------------

   A less than adequate rate of return is also a concern such that the 
propriety of investing large sums in an annuity contract or numerous 
contracts is also a consideration. However, as with insurance products, 
annuity contracts should be viewed in the context of the bank's overall 
asset and liability structure and not viewed in isolation in order to 
determine if they pose a significant risk to the fund.
   Because of the illiquid nature of long-term annuity contracts, 
banks often find it difficult to liquidate the contracts without 
incurring sizeable surrender charges. The illiquid nature of the 
assets, however, should be viewed from an overall impact on the bank in 
conjunction with other assets of the bank. Liquidity concerns may also 
be mitigated if banks have the ability to borrow against the contracts 
without incurring adverse surrender charges or adverse tax 
consequences. Due to the liquidity and credit risks, unduly large 
concentrations in investments in annuity contracts could result if a 
bank does not adopt prudent constraints on the amount of its exposures.

Approved Annuity Applications

   As of June 4, 1996, the FDIC has acted upon 2 annuity applications. 
These actions, all approvals, were taken by the Board of Directors. The 
actions were contingent upon conformance to specific conditions deemed 
necessary to limit the risk to the bank. Those conditions addressed 
concerns the FDIC Board of Directors had relative to these products.

Description of Proposed Exceptions

   As stated earlier, the FDIC is proposing to amend part 362 to 
provide a notice process for certain insured state banks proposing to 
invest in or retain real estate or life insurance and annuity 
contracts. Currently all insured state banks wishing to indirectly 
retain or acquire impermissible real estate investments, or directly or 
indirectly invest in nonconforming life insurance and annuity 
contracts, must apply to the FDIC for approval under section 24 of the 
FDIA and part 362. As detailed above, the FDIC Board has had a 
significant amount of experience with both types of applications and 
has concluded that it is possible for an insured state bank to engage 
in such activities without posing a significant risk to the deposit 
insurance fund. The FDIC recognizes that the application process can be 
costly and time consuming for insured state banks. Based on the Board's 
experience and the goal of relieving regulatory burden on insured state 
banks, the FDIC is proposing to amend its regulations to permit certain 
highly rated banks to engage in such activities under certain 
circumstances without the need for an application. The proposed 
exceptions would be added to the list of activities found in 
Sec. 362.4(c)(3) which the FDIC has found do not present a significant 
risk to the deposit insurance fund.

[[Page 43495]]

   The FDIC proposes to permit certain highly rated insured state 
banks to file notices 60 days prior to making an indirect investment in 
real estate or a direct or indirect investment in life insurance or 
annuity contracts. The procedures for filing, review and action on both 
types of notices are the same, however, there are certain conditions 
which insured state banks must meet in order to be eligible for the 
notice processing. The conditions in the case of real estate 
investments are more numerous and detailed than the conditions in the 
case of life insurance and annuity contract investments. For instance, 
banks wishing to invest in real estate must use a subsidiary organized 
solely for such purpose whereas banks will be permitted to directly own 
life insurance and annuity contracts. The conditions for bank 
eligibility are discussed below. The amount and type of information 
required in the notices to be filed with the FDIC regional offices 
differs significantly depending upon whether the bank is proposing to 
invest in real estate or life insurance and annuities.

Notice Procedure

   Notices are to be filed with, reviewed by and acted upon by the 
FDIC regional offices. Complete notices will normally be acted upon 
within 60 days of filing. Notices which do not include all the required 
information are not considered complete. The 60 day review period 
begins when all required information has been received by the FDIC 
regional offices. The FDIC regional offices will issue a letter to the 
insured state bank confirming receipt of the notice and advising the 
insured state bank of the date after which the bank may engage in the 
activity if the FDIC has not objected. The notice will be reviewed for 
the purpose of determining whether the bank is in fact eligible for the 
exception as well as for the purposes of determining whether particular 
facts and circumstances unique to the institution raise policy or legal 
concerns warranting additional action on the part of the FDIC. If 
safety or soundness issues are identified which do not rise to the 
level of presenting a significant risk to the deposit insurance fund, 
it is contemplated that the regional office will work with the bank 
during the notice period to correct the problems which have been 
identified.

FDIC Action on Notices

   The FDIC regional offices can issue a letter of nonobjection before 
the end of the 60 day notice period advising the bank that it may 
proceed with the proposed investment or activity. The FDIC regional 
offices could also issue to a bank a letter of objection before the end 
of the 60 day review period. A letter of objection would mean that the 
FDIC regional offices have determined that either the insured state 
bank does not qualify for notice processing or that the activity raises 
legal or policy concerns given the particular circumstances. If the 
regional offices determine that the bank does not meet the eligibility 
requirements or raises legal or policy concerns, the notice can be 
converted at the bank's option into an application and be processed in 
accordance with other provisions of part 362.
   The FDIC regional offices can extend the 60 day review period for 
an additional 30 days if it provides written notice of the extension to 
the insured state bank before the 60 day review period has run. The 
FDIC does not anticipate that extensions will occur frequently. FDIC 
regional offices should review and act on notices as quickly as 
possible, with the 60 day review period generally being seen as an 
outside limit.
   Should the FDIC regional offices fail to take written action by the 
end of the 60 day period, or the 90 day period if a 30 day extension 
has been taken, the FDIC shall be deemed to have issued a letter of 
nonobjection. In such event the insured state bank may engage in the 
activity on the terms and conditions as described in its notice, 
subject to the continued obligation to comply with the conditions set 
out in the exception. It is the FDIC's intent to normally respond to 
notices rather than to simply allow the notice period to expire.
   Issuance of a letter of nonobjection or permission to engage in the 
activity after the notice period expires does not preclude the FDIC 
from taking appropriate actions to address any safety and soundness 
concerns regarding the operation of a bank, any of its subsidiaries, or 
a particular investment in real estate or life insurance and annuities. 
If an insured state bank's financial or managerial resources suffer an 
adverse change, the FDIC retains its full authority to require the bank 
to take whatever steps FDIC deems appropriate.

Treatment of Outstanding FDIC Orders

   As noted above, a large number of insured state banks previously 
applied for and received approval from the FDIC to invest in real 
estate or life insurance and annuity contracts. The terms of the FDIC 
orders approving such applications will remain in effect and not be 
modified by the enactment of the proposal. To the extent those orders 
differ from the notice provisions in the proposed regulation, insured 
state banks may apply to the appropriate FDIC regional office for 
relief (provided the bank meets the eligibility requirements) by 
submitting a notice as required by the regulation and attaching a copy 
of the FDIC order which they are seeking to have rescinded. The terms 
of the FDIC order would remain in effect pending completion of the 
notice process.

Pending Applications

   If the proposal is adopted, insured state banks which have pending 
real estate or life insurance and annuity investment applications and 
which meet the conditions of eligibility in the proposed regulation may 
``convert'' their applications to notices by submitting a letter to the 
appropriate FDIC regional office requesting such treatment. The letter 
requesting such treatment should show that the bank meets the 
conditions of eligibility and contain such additional information as 
may be necessary to complete the notice. The FDIC regional office will 
either issue a letter to the insured state bank which states that the 
application has been converted to a notice and advising the insured 
state bank of the date after which the bank may engage in the activity 
if the FDIC has not objected or issue a letter to the insured state 
bank stating that the FDIC objects to the conversion request. In the 
event of FDIC objection to the conversion request, the application will 
continue to be processed in accordance with the other provisions of 
part 362.

Continued Compliance with Eligibility Conditions

   Banks which utilize the notice process to invest in real estate or 
life insurance and annuity contracts must continue to meet the 
conditions for eligibility set forth in the proposed regulation. Banks 
which fall out of compliance with any one of the eligibility conditions 
in the regulation are required to notify the FDIC regional office 
within 10 business days. The FDIC regional office shall review the 
notice and take such action as it deems necessary based on safety and 
soundness concerns. The FDIC regional offices have a broad range of 
authority with respect to the actions they can require the insured 
state bank to take. For example, the FDIC regional office may require 
the insured state bank to return to compliance within a specified 
period of time, to submit an application pursuant to Sec. 362.4(d), to 
submit a capital restoration plan, or in appropriate cases to divest 
the investment.

[[Page 43496]]

Notice--Real Estate Investments

Section 362.4(c)(3)(vi)(A)--Conditions for Bank Eligibility
   The notice process is available only to those insured banks which 
propose to hold their real estate investments through a majority-owned 
subsidiary. Structure is important with respect to real estate 
investments. As noted above, the holding of real estate investments 
through a subsidiary will provide some liability protection to the 
bank, and ultimately the deposit insurance fund, should there be any 
adverse litigation or hazardous environmental waste problems. In 
addition, the subsidiary must be ``solely'' for the purpose of real 
estate investments. Sole purpose subsidiaries will simplify reporting 
and monitoring of the real estate investments. Insured state banks 
which would like to operate mixed use subsidiaries for real estate 
investments will be required to go through the normal part 362 
application process.
   There are nine conditions for banks that want to invest in real 
estate using the notice process. The bank must have either a 1 or 2 
UFIRS composite rating as assigned by the FDIC as of the most recent 
rating period. The FDIC believes that only those banks which have 
composite ratings of 1 or 2 are appropriate for the notice process. 
These institutions have shown that they have the requisite financial 
and managerial resources to run a financial institution without 
presenting a significant risk to the deposit insurance fund. While 
other lower rated financial institutions may have the requisite 
financial and managerial resources and skills to undertake real estate 
investments, the FDIC believes that those institutions should be 
subject to the formal part 362 application process as opposed to the 
streamlined notice process described herein.
   The bank must be ``well capitalized'' as defined in part 325 of 
this title after deducting the proposed real estate investment from 
capital calculations. This eligibility condition reflects the FDIC's 
belief that only those insured state banks with strong capital 
positions should be investing in real estate. Bank capital is designed 
to act as a cushion in the event of losses. As noted above, the 
variability of returns on real estate investments is very wide. Banks 
can not count on any return on their real estate investments, and may 
in fact end up losing the entire investment. For this reason, the FDIC 
believes the capital deduction reflects a more accurate assessment of 
the bank's capital position.
   As noted above, to be eligible for notice processing a bank must 
use a subsidiary for the real estate investment. The real estate 
subsidiary must meet several conditions. First, the subsidiary must 
meet the definition of ``bona fide subsidiary'' as contained in 
Sec. 362.2(d), except a majority of the subsidiary's officers and 
directors may be directors or executive officers of the bank. However, 
the subsidiary must have at least one director who is knowledgeable 
with respect to real estate investment activities and is not an 
employee, officer or director of the bank. This requirement is to 
assure that the real estate subsidiary is in fact a separate and 
distinct entity. As discussed above, this requirement should insulate 
the bank and the deposit insurance fund from liabilities in excess of 
the bank's investment.
   The FDIC believes that banks that want to engage in real estate 
investment should have subsidiaries with board members that will manage 
using proven experience in real estate as such experience will greatly 
increase the likelihood of successful investment. The independent board 
member must be an individual who is not an employee, officer or 
director of the bank and who is knowledgeable with respect to real 
estate investment activities. An independent director should bring 
valuable experience to the subsidiary's operations. Officers, directors 
or employees of the bank's holding company or of an affiliate of the 
bank are eligible to fill the independent director requirement.
   The bank must have a written business plan for the real estate 
investment which is acceptable to the FDIC. Banks that want to engage 
in real estate investment should have a written business plan which is 
detailed and well thought out. Such a plan is yet another indicator 
that the financial institution has adequate managerial resources to 
engage in the proposed activity.
   All transactions between the bank and the subsidiary should conform 
to the restrictions that would apply under sections 23A and 23B of the 
Federal Reserve Act as between a bank and its affiliate. This 
requirement is intended to make sure that adequate safeguards are in 
place for the dealings between the bank and its subsidiary. The FDIC 
invites comment on whether all the provisions of sections 23A should be 
imposed or whether just certain restrictions are necessary. For 
instance, should the regulation simply provide that the bank's 
investment in the real estate subsidiary is limited to 10% of capital 
and that there is an aggregate investment limit of 20% for all 
subsidiaries rather than in effect subject transactions between the 
bank and its real estate investment subsidiary to all of the 
restrictions of section 23A of the Federal Reserve Act. If the FDIC 
were to do so, it would be the Agency's intent to monitor transactions 
between the bank and its subsidiary as part of the FDIC's regulatory 
oversight of the bank and to address any concerns on a case-by-case 
basis.
   Finally, two restrictions are imposed which are designed to address 
tying and insider abuse. First, with respect to tying, neither the bank 
nor the subsidiary may engage in any transaction which requires a 
customer of either to buy any product or use any service of either as a 
condition of entering into the transaction. This restriction on tying 
transactions is broader than the conditions in previous FDIC Board 
Orders in that it would cover any product or service which either the 
bank or the subsidiary offers. The FDIC requests comment on whether the 
tying restriction is broader than necessary. Commenters who believe the 
tying restriction should be limited to loans by the bank to customers 
of the real estate subsidiary should explain why these loans are the 
only problematic transactions.
   The second restriction is neither the bank nor the subsidiary may 
engage in any transaction with a bank insider (or a related interest) 
which involves the real estate investment activities of the subsidiary 
unless the FDIC regional office approves the transaction in advance. 
This restriction does not apply, however, to extensions of credit which 
are subject to Sec. 337.3 of this title. This exception carves out 
those extensions of credit by a bank to its executive officers, 
directors and principal shareholders, and their related interests, 
which comply with Regulation O. 12 CFR 215, subpart A.
Section 362.4(c)(3)(vi)(B)--Contents of Notice
   Insured state banks which meet the conditions for eligibility would 
be required to file a notice with the appropriate FDIC regional office. 
The amount of information required in the real estate investments is 
greater than that required in the case of life insurance and annuity 
investments. The regulation sets forth seven (7) specific information 
requirements, which are:
   (B)(1). A brief description of the real estate investment 
activities. The notice should describe the proposed investment, e.g., 
purchase of raw land, interest in a shopping center or construction of 
a small office building,

[[Page 43497]]

and identify where the real estate is located.
   (B)(2). A copy of the real estate investment business plan. This 
written document should discuss all aspects of the proposed business, 
capitalization, cash flows, expenses, market variables, etc. Banks 
without written business plans will not be permitted to file notices.
   (B)(3). A description of the subsidiary's operations including 
management's expertise. The FDIC believes that experienced real estate 
management is very important to the success of a subsidiary engaged in 
real estate activities. The notice shall contain a detailed discussion 
of management's real estate experience in the particular type of real 
estate investment contemplated. For instance, if the subsidiary is 
going to engage in residential real estate development, the application 
should discuss managements proven experience in residential real estate 
development.
   (B)(4). The amount of bank's aggregate investment in the subsidiary 
stated as a percentage of Tier 1 Capital. The notice should state 
clearly the amount of investment which a bank has in the real estate 
subsidiary. This includes both direct (such as contributions of capital 
and loans to the subsidiary) and indirect investments (such as 
extensions of credit or commitments of credit to third parties who will 
be making direct investments in the subsidiary). Further, a bank shall 
also include in its calculation any extension of credit or commitment 
of credit to a third party which will be making an investment in any 
investment which the subsidiary has an interest. Banks should not 
include in their calculation of investment any retained earnings or the 
value of any assets which the subsidiary may hold. Notices should 
quantify and separately identify the direct and indirect real estate 
investments.
   (B)(5). Bank's capital after deducting the investment in real 
estate. The notice should state clearly what the bank's capital 
position is after deducting the investment in real estate. The bank 
should set forth its 3 capital categories as of the latest call report 
in both dollars and percentages. The notice should also show on a pro 
forma basis what the bank's Tier 1 Capital will be, on both a dollar 
and percentage basis, after making the required deduction. Stating this 
information clearly in the notice will assist the FDIC regional office 
in reviewing and acting upon the bank's notice.
   (B)(6). A copy of the board of director's resolution authorizing 
the filing of the notice. The notice should state the bank's board of 
directors has authorized the proposed investment in real estate, 
including the formation of a majority-owned subsidiary solely for the 
purpose of investing in real estate, and authorized the filing of the 
notice with the FDIC. A copy of the Board resolution(s) should be 
attached to the notice.
   (B)(7). The relevant state law which authorizes the bank subsidiary 
to conduct real estate investment activities. The notice should 
identify the relevant state statute, regulation or guideline which 
permits the bank's subsidiary to invest in real estate. If an 
application or some other type of approval from the state banking 
regulator is required, the state banking regulator's approval or 
nonobjection should be referenced. A copy of such approval or 
nonobjection letter should be attached to the notice. The FDIC can not 
authorize insured state banks to invest in real estate unless they are 
permitted to do so under existing state law. For this reason it is 
important that banks identify the relevant state statutes, regulations 
or other provisions of law which permit them to engage in such 
activities. Again, such information will greatly assist the FDIC 
regional offices in reviewing the notices as expeditiously as possible.

Notice--Life Insurance and Annuity Products

Section 362.4(c)(3)(vii)--Condition for Bank Eligibility
   The bank eligibility conditions are somewhat less restrictive for 
investing in life insurance and annuity products than for real estate 
investments. For instance, insured state banks wishing to invest in 
life insurance and annuities are generally not required to use a 
subsidiary for such investments and there is no capital ``deduction'' 
for life insurance and annuity investments. The less restrictive 
eligibility requirements are reflective of the FDIC's view that life 
insurance and annuity investments are generally less risky investments 
than real estate investments.
   There are six conditions for banks wishing to invest in life 
insurance or annuity contracts pursuant to a notice. The bank must be 
well capitalized as defined in part 325. The bank's most recent UFIRS 
rating as assigned by the FDIC must be a ``3'' or better. The bank must 
have in place policies and procedures for monitoring the financial 
health of the companies issuing or underwriting the life insurance or 
annuity contracts.
   There are two percentage of Tier 1 Capital investment limits for 
annuities and life insurance policies. The bank's total aggregate 
investment in annuity contracts and life insurance policies which are 
impermissible for national banks (nonconforming) can not exceed 30% of 
the bank's tier 1 capital. The bank's total aggregate investment in all 
types of annuity contracts and life insurance policies can not exceed 
50% of the bank's Tier 1 capital. (A)(4). The 50% limit would include 
both the national bank permissible life insurance policies as well as 
those which are not permissible for national banks to hold. Banks are 
also required to diversify their annuity contract and life insurance 
policy risks. In order to be eligible for the notice process, a bank's 
total investment in conforming and nonconforming investments from 
anyone issuer cannot exceed a maximum of 15% of the bank's Tier 1 
capital.
   Banks are also required to purchase annuities and life insurance 
policies from highly rated issuers. Under the regulation, banks are not 
eligible for the notice process if they have purchased annuity 
contracts or life insurance policies from issuers that are not in the 
top two categories of a nationally recognized rating service. There are 
several national organizations which rate insurance companies: these 
organizations include A.M. Best, Standard & Poors and Moody's.
   As noted above, banks are not generally required to purchase or 
hold life insurance policies or annuity contracts through a subsidiary. 
Some life insurance policies and annuity contracts are ``securities'' 
for purposes of the Federal securities laws. All annuity contracts 
which are considered to be ``securities'' must be held through a 
subsidiary of the bank. Those life insurance policies which do not 
qualify under OCC BC 249 and which are considered to be ``securities'' 
must also be held through a subsidiary of the bank. Holding such 
securities through a subsidiary of the bank is required pursuant 
section 24 and part 362.
Section 362.4(c)(3)(vii)(B)--Contents of Notice
   Insured state banks which meet the six conditions for eligibility 
noted above would be required to file a notice with the appropriate 
FDIC regional office. The amount of information required in the life 
insurance and annuity investment notices is less than that required in 
the real estate investment notices. The regulation sets forth seven (7) 
specific information requirements for

[[Page 43498]]

the life insurance and annuity investment notices. They are:
   (B)(1). The aggregate amount of direct and indirect investment in 
life insurance policies and annuity contracts stated as a percentage of 
the bank's Tier 1 Capital. The notice should state clearly the number 
of annuity contracts and life insurance policies which the bank owns 
(or intends to acquire), either directly or through a subsidiary. The 
notice should also state the dollar value of the annuity contracts and 
life insurance policies and what percentage of the bank's tier one 
capital that represents. Banks should not include in this provision any 
life insurance policies which a national bank would be permitted to own 
under either Test A or Test B of OCC Banking Circular 249.
   (B)(2). The aggregate amount of direct and indirect investment in 
all life insurance policies and annuity contracts as a percentage of 
the bank's Tier 1 capital. This item includes conforming as well as 
nonconforming investments in life insurance policies. The notice should 
identify those life insurance policies which conform to either Test A 
or Test B of BC 249 and the value of such life insurance policies.
   (B)(3). The concentration of investment by issuer. The notice shall 
clearly state the aggregate amount of bank investment in annuity 
contracts and life insurance policies from any one issuer. The FDIC is 
concerned about concentration of risk from one issuer, therefore banks 
should aggregate life insurance policies and annuity contracts issued 
by the same company.
   Calculations shall be stated as a percentage of the bank's tier one 
capital. All life insurance policies, even those which may be 
permissible for a national bank under OCC BC 249, should be included in 
the calculation.
   (B)(4). The rating of the issuer(s) of the policies and annuity 
contracts. The notice should state the most current rating of the 
issuer by the nationally recognized rating services which rate the 
issuer. The issuer must be in one of the top two rating categories of 
the rating service. If the issuer is not in one of the top two rating 
categories, the bank is not eligible for the notice process. If the 
issuer is rated by more than one of the nationally recognized rating 
services and the issuer is not in the top two rating categories of all 
services the FDIC may object to the notice.
   (B)(5). A description of the bank's monitoring procedures. The 
notice shall identify and briefly describe the bank's procedures for 
monitoring the financial health of the issuer. The notice shall, at a 
minimum, identify the individual or committee responsible for 
monitoring the financial status of the issuer and how frequently the 
monitoring is done. If the procedures are in writing, they should be 
attached to the notice.
   (B)(6). The relevant state law which authorizes the bank investment 
in life insurance policies or annuity contracts should be identified. 
The notice should identify the relevant state statute, regulation or 
guideline which permits insured state banks to invest in life insurance 
policies or annuity contracts. If an application or some other type of 
approval from the state banking regulator is required, the state 
banking regulator's approval or nonobjection should be referenced. A 
copy of such approval or nonobjection letter should be attached to the 
notice. The FDIC can not authorize insured state banks to invest in 
life insurance policies or annuity contracts unless they are permitted 
to do so under existing state law. For this reason it is important that 
banks identify the relevant state statutes, regulations or other 
provisions of law which permit them to engage in such activities. 
Again, such information will greatly assist the FDIC regional offices 
in reviewing and acting on the notices as expeditiously as possible.
   (B)(7). A copy of the board of director's resolution authorizing 
the filing of the notice. The notice should state that the bank's board 
of directors have authorized the proposed investment in life insurance 
policies or annuity contracts and authorized the filing of the notice 
with the FDIC. A copy of the Board resolution(s) should be attached to 
the notice.

Regulatory Flexibility Analysis

   The Board of Directors has concluded after reviewing the proposed 
regulation that the regulation, if adopted, will not impose a 
significant economic hardship on small institutions. This proposal 
simplifies and streamlines the timing and information small entities 
must file to engage in profit-making activities thereby reducing their 
regulatory burden. By expediting processing and allowing small entities 
to engage in profit-making activities more quickly, small entities may 
avoid lost opportunity costs. The Board of Directors therefore hereby 
certifies pursuant to section 605 of the Regulatory Flexibility Act (5 
U.S.C. 605) that the proposal, if adopted, will not have a significant 
economic impact on a substantial number of small entities within the 
meaning of the Regulatory Flexibility Act (5 U.S.C. 601 et. seq.).

List of Subjects in 12 CFR Part 362

   Administrative practice and procedure, Authority delegations 
(Government agencies), Bank deposit insurance, Banks, banking, Insured 
depository institutions, Investments, Reporting and recordkeeping 
requirements.
   For the reasons set forth above, the FDIC hereby proposes to amend 
12 CFR part 362 as follows.

PART 362--ACTIVITIES AND INVESTMENTS OF INSURED STATE BANKS

   1. The authority citation for part 362 continues to read as 
follows:

   Authority: 12 U.S.C. 1816, 1818, 1819[Tenth], 1831a.

   2. Section 362.4 is amended by adding new paragraphs (c)(3)(vi) and 
(c)(3)(vii) to read as follows:

Sec. 362.4  Activities of insured state banks and their subsidiaries.

* * * * *
   (c) * * *
   (3) * * *
   (vi) Equity interests in real estate. (A) An insured state bank may 
invest in and/or retain equity interests in real estate through a 
majority-owned subsidiary organized solely for such purpose provided 
that the bank has filed written notice as described in paragraph 
(c)(3)(vi)(B) of this section at least 60 days prior to making the 
initial investment, the FDIC has not objected to the investment prior 
to the expiration of the 60-day notice period nor extended the notice 
period an additional 30 days and objected to the investment prior to 
the expiration of the extended notice period, and the following 
conditions are, and continue to be, met:
   (1) The bank is well-capitalized as defined in part 325 of this 
chapter exclusive of the bank's investment in the subsidiary as well as 
any extensions of credit 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;
   (2) The bank makes the deduction in paragraph (c)(3)(vi)(A)(1) of 
this section for purposes of determining capital as reported on the 
bank's report of condition and assessment risk classification purposes 
in part 327 of this chapter and prompt corrective action purposes under 
part 325 of this chapter provided, however, that the deduction shall 
not be used for the purposes of determining whether the bank is 
``critically undercapitalized'' as defined under part 325 of this 
chapter;

[[Page 43499]]

   (3) The bank's most current composite rating assigned by the FDIC 
under the Uniform Financial Institutions Rating System or such other 
comparable rating system as may be adopted by the FDIC in the future is 
1 or 2;
   (4) The subsidiary meets the definition of ``bona fide subsidiary'' 
as contained in Sec. 362.2(d) except that the requirements of 
Sec. 362.2(d)(6) and (d)(7) are waived provided that the subsidiary has 
at least one director who is knowledgeable with respect to real estate 
investment activities and is not an employee, officer or director of 
the bank;
   (5) The subsidiary is managed by persons who have expertise in the 
real estate investment activities conducted by the subsidiary;
   (6) The subsidiary has a written business plan regarding the real 
estate investment activities;
   (7) Transactions between the bank and the subsidiary comply with 
the restrictions of sections 23A and 23B of the Federal Reserve Act (12 
U.S.C. 371c and 371c-1) to the same extent as though the subsidiary 
were an affiliate of the bank as the term affiliate is defined for the 
purposes of section 23A and section 23B except that extensions of 
credit made by the bank to finance sales of assets by the subsidiary to 
third parties need not comply with the collateral requirements and 
investment limitations of section 23A provided that such extensions of 
credit are consistent with safe and sound banking practice, do not 
involve more than the normal degree of risk of repayment, and 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;
   (8) Neither the bank nor the subsidiary shall engage in any 
transaction which requires a customer of either to buy any product or 
use any service of either as a condition of entering into a 
transaction; and
   (9) Neither the bank nor the subsidiary engages in any transactions 
(exclusive of those covered by Sec. 337.3 of this chapter) with 
insiders of the bank as insider is defined in Federal Reserve Board 
Regulation O (12 CFR 215.2(h)), which relate to the subsidiary's real 
estate investment activities without the prior written consent of the 
appropriate regional director for the Division of Supervision.
   (B) Notice filed pursuant to paragraph (c)(3)(vi)(A) of this 
section may be in letter form and should be filed with the regional 
director for the Division of Supervision for the FDIC region in which 
the bank's principal office is located. The regional office will send 
written acknowledgment of receipt of a completed notice to the bank 
which shall indicate the date after which the bank may initiate the 
investment activities if the FDIC has neither objected to the notice 
nor extended the notice period. The notice period will begin to run 
from the date the acknowledgment is sent. If the notice period is 
extended, the bank will be notified in writing and informed of the date 
after which the bank may initiate the investment activities if the FDIC 
does not object. Notices shall contain the following:
   (1) A description of the real estate investment activities;
   (2) A copy of the business plan concerning the real estate 
investment activities;
   (3) A description of the subsidiary's operations including a 
discussion of management's expertise;
   (4) The aggregate amount of the bank's investment in the subsidiary 
as defined in Sec. 362.2(q), which does not include retained earnings, 
and the bank's extensions of credit and commitments of credit to 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 stated as a percentage of tier one capital;
   (5) The bank's capital after adjustments are made for the 
deductions described in paragraph (c)(3)(vi)(A)(1) of this section;
   (6) A copy of the board of directors' resolution authorizing the 
filing of the notice; and
   (7) An identification of the relevant state statute, regulation or 
other authority which authorizes the subsidiary to conduct real estate 
investment activities.
   (C) An insured state bank which falls out of compliance with any of 
the eligibility conditions in paragraph (c)(3)(vi)(A) of this section 
shall notify the FDIC regional office within 10 business days of 
falling out of compliance. The FDIC regional office shall review the 
notice and take such action as it deems necessary. Such actions may 
include, but are not limited to, requiring the insured state bank to 
file an application pursuant to paragraph (d) of this section, 
requiring the submission of a capital restoration plan or requiring the 
divestiture of such investment.
   (vii) Life insurance policies and annuity contracts. (A) An insured 
state bank may invest in and/or retain life insurance policies and 
annuity contracts, either directly or indirectly through a majority-
owned subsidiary of the bank, provided that the bank has filed written 
notice as described in paragraph (c)(3)(vii)(B) of this section at 
least 60 days prior to making the initial investment, the FDIC has not 
objected to the investment prior to the expiration of the 60-day notice 
period nor extended the notice period an additional 30 days and 
objected to the investment prior to the expiration of the extended 
notice period, and the following conditions are, and continue to be, 
met:
   (1) The bank is well-capitalized as defined in part 325 of this 
chapter;
   (2) The bank's most current composite rating as assigned by the 
FDIC under the Uniform Financial Institutions Rating System or such 
other comparable rating system adopted by the FDIC in the future is at 
least 3;
   (3) The bank's total aggregate direct and indirect investment in 
annuity contracts and life insurance policies which do not conform to 
OCC Banking Circular 249 does not exceed 30% of the bank's tier one 
capital;
   (4) The bank's total aggregate direct and indirect investment in 
all annuity contracts and life insurance policies (conforming and 
nonconforming) is no greater than 50% of the bank's tier one capital 
and the bank's total aggregate direct and indirect investment in all 
annuity contracts and life insurance policies (conforming and 
nonconforming) from the same issuer does not exceed 15% of the bank's 
tier one capital;
   (5) The issuer(s) of the life insurance policies and annuity 
contracts (conforming and nonconforming) is (are) rated in the top two 
rating categories by a nationally recognized rating service; and
   (6) The bank's board of directors has procedures in place to 
monitor the financial condition of the issuer(s) of the life insurance 
policies and annuity contracts (conforming and nonconforming).
   (B) Notice filed pursuant to paragraph (c)(3)(vii)(A) of this 
section may be in letter form and should be filed with the regional 
director for the Division of Supervision in the region in which the 
bank's principal office is located. The regional office will send 
written acknowledgment of receipt of a completed notice to the bank 
which shall indicate the date after which the bank may initiate the 
investment activities if the FDIC has neither objected to the notice 
nor extended the notice period. The notice period will begin to run 
from the date the acknowledgment is sent. If the notice period is 
extended, the bank will be notified in writing and informed of the

[[Page 43500]]

date after which the bank may initiate the investment activities if the 
FDIC does not object. Notices shall contain the following:
   (1) The aggregate amount of direct and indirect investment in 
annuity contracts and nonconforming life insurance policies stated as a 
percentage of the bank's tier one capital;
   (2) The aggregate amount of direct and indirect investment in all 
annuity contracts and life insurance policies (conforming and 
nonconforming) stated as a percentage of the bank's tier one capital;
   (3) The aggregate amount of direct and indirect investment in all 
annuity contracts and life insurance policies (conforming and 
nonconforming) from any one issuer stated as a percentage of the bank's 
tier one capital;
   (4) The rating of the issuer(s) of the policies and annuity 
contracts;
   (5) A description of the bank's monitoring procedures;
   (6) The state statute, regulations or other authority which 
authorizes the bank to make the investment; and
   (7) A copy of the board of directors' resolution authorizing the 
filing of the notice.
   (C) An insured state bank which falls out of compliance with any of 
the eligibility conditions in paragraph (c)(3)(vii)(A) of this section 
shall notify the FDIC regional office within 10 business days of 
falling out of compliance. The FDIC regional office shall review the 
notice and take such action as it deems necessary. Such actions may 
include, but are not limited to, requiring the insured state bank to 
file an application pursuant to paragraph (d) of this section, 
requiring the submission of a capital restoration plan or requiring the 
divestiture of such investment.

Sec. 362.6  [Amended]

   3. Section 362.6 is amended by adding ``the authority to act on 
notices filed pursuant to Sec. 362.4(c)(3)(vi) (A) and (C) and 
Sec. 362.4(c)(3)(vii) (A) and (C); the authority to rescind orders 
issued pursuant to Sec. 362.4 where it is determined that the 
institution is eligible to engage in activities pursuant to an 
exception contained in Sec. 362.4(c)(3);'' immediately after 
``Sec. 362.3(d);''.

   By Order of the Board of Directors.

   Dated at Washington, D.C., this 13th day of August, 1996.

Federal Deposit Insurance Corporation.
Jerry L. Langley,
Executive Secretary.
[FR Doc. 96-21475 Filed 8-22-96; 8:45 am]
BILLING CODE 6714-01-P