Application Pursuant to Section 24 of the
Federal Deposit Insurance Act to Indirectly Continue
Activity That May Not Be Permissible for a National Bank
Pursuant to the provisions of Section 24 of the Federal Deposit Insurance Act, an application has been filed with the Federal Deposit Insurance Corporation by Surety Bank, Vallejo, California (Surety). The bank requests FDIC consent to allow its proposed wholly-owned subsidiary (Subsidiary), to retain 100 percent interest in realty property located in Vallejo, California, until it is able to divest of said property, but in no event later than December 31, 1998. The property is a commercial building, previously bank premises.
In general, real estate investment may not be a permissible activity for a national bank or a subsidiary of a national bank. Subsidiaries of state-chartered, FDIC-insured banks may not engage as principal in an activity prohibited to subsidiaries of nationally chartered banks unless the bank is in compliance with applicable capital standards and the FDIC determines that the activity poses no significant risk to the deposit insurance fund. California banking statutes permit the holding of subject real estate investment.
The bank constructed the subject building in 1987 to house the then savings and loan's operations staff. The bank plans to transfer the investment to Subsidiary. The bank has made reasonable effort to divest of the property; however, the current real estate market is such that near term divestiture would likely result in a loss. Bank management has indicated that the bank has no intention of engaging in real estate activities once the remaining lot is liquidated.
The bank meets the definition of "Well Capitalized" in the FDIC's Rules and Regulations in 12 C.F.R. Section 325.103. The book value of the subject property is $270,000. Once title to the property is transferred to Subsidiary, it will represent approximately 5.4 percent of Tier 1 Capital.
Real estate investment is subject to a high degree of market risk and other specialized risks specific to real estate ownership and may be of questionable benefit in the diversification of a financial institution's portfolio of assets. Due to these risks, real estate investment activities appear suitable to a financial institution only on a very limited scale and under restrictive conditions designed to control the various risks posed to the financial institution and the deposit insurance fund. In connection with this application, the FDIC has also taken into consideration the financial and managerial resources and future earnings prospects of the bank.
As prudential limitations and restrictions addressing the risks posed by real estate investment activities will be imposed, the subsidiary's real estate investment activities will not constitute a significant risk to the Bank Insurance Fund or present material safety and soundness concerns.
Based upon careful evaluation of all available facts and information, the Acting Associate Director, acting under delegated authority, has concluded that approval of the application is appropriate subject to the restrictions discussed below. The following conditions are imposed for prudential reasons due to the volatility and other risks which are inherent in the subject real estate activity as well as to mitigate any potential insider conflicts of interests or risks associated with transactions between the bank and the subsidiary:
That Surety establish Subsidiary and transfer ownership of the real estate investment to Subsidiary immediately;
That Surety and Subsidiary shall take the necessary steps to operate the subsidiary in a manner which ensures a separate corporate existence as a majority-owned subsidiary that:
(a) is adequately capitalized,
(b) is separate and distinct in its operations from Surety's operations,
(c) maintains separate accounting and other corporate records,
(d) observes separate formalities such as separate board of directors' meetings,
(e) maintains a board of directors with management expertise capable of conducting
activities in a safe and sound manner,
(f) contracts with the bank for any service on terms and conditions comparable to those available to or from independent entities, and
(g) conducts business pursuant to separate policies and procedures designed to inform Surety's customers and prospective customers of Subsidiary that the subsidiary is a separate organization from Surety, 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.
That Surety's indirect real estate investment activities shall be limited to that which is currently held directly, including:
(a) equity interests,
(b) debt obligations of Subsidiary held by Surety,
(c) bank guarantees of debt obligations issued by Subsidiary, and
(d) extensions of credit or commitments of credit to any third party for the purpose of
making a direct investment in Subsidiary or making an investment in any investment in
which Subsidiary has an interest.
That Subsidiary shall divest of all property held by December 31, 1998.
That Surety and Subsidiary shall not engage in any transactions with insiders of Surety or their related interests which relate to Subsidiary's real estate investment activities without the prior written consent of the appropriate DOS Regional Director.
That Surety shall not condition any loan on the purchase of real estate from the subsidiary engaging in real estate investment activities and shall not extend credit to any borrower to acquire real estate from Subsidiary unless:
(a) it is consistent with safe and sound banking practice and does not involve more than a normal degree of risk of repayment, and
(b) the credit is extended on terms and under circumstances, including credit standards, that are substantially the same, or at least as favorable to Surety, as those prevailing at the time for comparable transactions.
That transactions between Surety and Subsidiary shall be made in accordance with the restrictions of Sections 23A and 23B of the Federal Reserve Act, 12 U.S.C. Sections 371c and 371c-1, to the same extent as though Subsidiary was an affiliate of Surety. With the exceptions that the amount and collateral limitations of Section 23A shall not apply to loans made by Surety to facilitate the sale of the real estate investment held by Subsidiary, provided the loans:
(a) are consistent with safe and sound banking practices, and
(b) 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 Surety, as those prevailing at the time for comparable transactions.
That consent is granted based on the facts and circumstances presented or otherwise known to the FDIC in connection with this request. Surety shall notify the FDIC of any significant change in facts or circumstances, and the FDIC shall have the right to alter, suspend, or withdraw its approval.
Finally, FDIC notes that the foregoing approval is unique to this application, that it was significantly influenced by Subsidiary's acquisition of the subject real estate interest prior to the effective date of Section 24, and that its view of de novo acquisition of such interest might well be different.