Decisions on Bank Applications
Merchants & Planters' Bank
FEDERAL DEPOSIT INSURANCE CORPORATION
IN RE: Merchants & Planters' Bank Newport, Arkansas
Application Pursuant to Section 24 of the Federal Deposit Insurance Act for Consent to Indirectly Engage as Principal Through a Wholly-Owned Subsidiary in Real Estate Investment Activities That May Not Be Permissible for a Subsidiary of a National Bank
ORDER
The Board of Directors ("Board") of the Federal Deposit Insurance Corporation ("FDIC") has fully considered all available facts and information relevant to section 24 of the Federal Deposit Insurance Act, 12 U.S.C. § 1831a, and Part 362 of the FDIC's Rules and Regulations,12 C.F.R. Part 362 ("Part 362"), relating to an application by Merchants & Planters' Bank, Newport, Arkansas ("Bank"), for consent to indirectly engage as principal through a wholly-owned subsidiary, Three Rivers Realty, Inc. ("Subsidiary"), in equity real estate investment activities that may not be permissible for a subsidiary of a national bank. The Board, having found that the Bank is in compliance with applicable capital standards and that the activity to be initiated does not appear, with certain conditions imposed, to pose a significant risk to the applicable deposit insurance fund, has concluded the application should be approved subject to certain conditions.
Accordingly, it is hereby ORDERED, for the reasons set forth in the attached Statement, that the application submitted by the Bank for consent to indirectly engage as principal through the Subsidiary in real estate investment activities that may not be permissible for a subsidiary of a national bank be and the same hereby is approved, subject to the following conditions:
1. That the Bank shall take the necessary actions to operate the Subsidiary in a manner so as to ensure that the Subsidiary has a separate corporate existence as a wholly-owned subsidiary which:
a. is adequately capitalized
b. is physically separate and distinct in its operations from the operations of the Bank;
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 one or more independent, knowledgeable outside directors and 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 customers and prospective customers of the Subsidiary that the Subsidiary 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.
2. That the Bank's Real Estate Investment Activity Investment as defined below) in the Subsidiary shall be limited to an aggregate outstanding at any one time of $200,000 and to those proposed types of activities described in the attached Statement.
3. That the Bank shall continue to meet all applicable capital standards and the Bank's capital level after deducting the Real Estate Investment Activity Investment in subsidiaries equal or exceed the level required for a "well capitalized" institution pursuant to section 325.103(b)(1) of the FDIC's Rules and Regulations.
4. That the Bank shall, on a quarterly basis, perform the capital adequacy calculations described in paragraph 3 above for the purpose of ascertaining its capital level, and that, in the event the Bank falls below the level required for a "well capitalized" institution pursuant to section 325.103(b)(1) of the FDIC's Rules and Regulations, the Bank shall notify the FDIC within 15 days and submit to the FDIC an acceptable plan for restoring capital to a level required for a "well capitalized" institution.
5. That, henceforth, notwithstanding Parts 325 and 327 of the FDIC's Rules and Regulations, 12 C.F.R. Parts 325 and 327, the Bank's capital category for purposes of Prompt Corrective Action and the Bank's risk-adjusted deposit insurance premium assessment shall be calculated based on the Bank's capital after deducting all Real Estate Investment Activity Investments except that such deductions shall not be made when determining whether the Bank is "critically undercapitalized" as defined under Part 325 of the FDIC's Rules and Regulations.
6. That any extensions of credit by the Bank to any third parties shall be clearly disclosed to the Bank's board of directors prior to approval of the extension of credit and shall be documented in the board's minutes if such extension of credit to the third party:
a. is for the purpose of making a direct investment in a Subsidiary engaging in real estate investment activities or in a Subsidiary's real estate investment activity; or
b. involves the acceptance of a debt obligation of, or equity interest in, a Subsidiary engaging in real estate investment activities as collateral security for such extension of credit.
7. That before the consummation of a transaction between the subsidiary engaging in real estate investment activities and any of the Bank's customers, any potential conflicts of interest be identified, be appropriately resolved, and be clearly disclosed to the Bank's board of directors and documented in the board's minutes.
8. That the Bank and its Subsidiary shall not engage in any transactions with insiders of the Bank or their related interests which relate to the Subsidiary's real estate investment activities without the prior written consent of the appropriate Regional Director of the FDIC's Division of Supervision.
9. That the Bank shall not:
a. condition any loan on the purchase or rental of real estate from the Subsidiary engaging in real estate investment activities;
b. purchase real estate from the Subsidiary in its trust capacity unless expressly authorized by the trust instrument, court order, or state law; and
c. extend credit to any borrower to acquire real estate from the Subsidiary engaging in real estate investment activities (End Loans) unless it is consistent with safe and sound banking practice, does not involve more than the normal degree of risk of repayment, and 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.
10. That transactions between the Bank and the Subsidiary engaging in real estate investment activities shall be made in accordance 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 defined under sections 23A and 23B, with the exception that the collateral requirements and investment limitations of section 23A shall not apply to loans made by the Bank to finance bona fide sales of assets to third parties consistent with safe and sound underwriting requirements contained in paragraph 9(c) above.
11. That the consent granted herein is based on the facts and circumstances presented or otherwise known to the FDIC in connection with this request. The Bank shall notify the FDIC of any significant change in facts or circumstances. If the facts and circumstances change significantly, the FDIC shall have the right to alter, suspend, or withdraw its approval.
Definitions. Except as otherwise set forth in this Order, capitalized terms used herein shall have the meanings set forth below:
a. "Real Estate Investment Activity" shall have the same meaning as "Equity Interest In Real Estate" as defined by section 362.2(j) of the FDIC Rules and Regulations.
b. "Real Estate Investment Activity Investment" means the Bank's investment in the Subsidiary, including, equity interests, debt obligations of the Subsidiary held by the Bank, the Bank's guarantees of debt obligations issued by the Subsidiary, extensions of credit or commitments of credit from the Bank to the Subsidiary, and any extensions of credit to any third parties for the purpose of making a direct investment in any Subsidiary or making an investment in any equity investment in real estate in which the Subsidiary has an interest. However, Real Estate Investment Activity Investment shall not include: a) loans made by the Bank to finance End Loans; nor b) the existing paid in capital and surplus of the Subsidiary; nor c) other equity interests, debt obligations of the Subsidiary held by the Bank, the Bank's guarantees of debt obligations issued by the Subsidiary, extensions of credit or commitments of credit from the Bank to the Subsidiary, or any extensions of credit to any third parties for the purpose of making a direct investment in the Subsidiary PROVIDED these investments pertain only to the Bank's real estate acquired for debt previously contracted being held for liquidation purposes by the Subsidiary.
FEDERAL DEPOSIT INSURANCE CORPORATION
IN RE: Merchants & Planters' Bank Newport, Arkansas
Application Pursuant to Section 24 of the Federal Deposit Insurance Act for Consent to Indirectly Engage as Principal Through a Wholly-Owned Subsidiary in Real Estate Investment Activities That May Not Be Permissible for a Subsidiary of a National Bank
STATEMENT
Pursuant to the provisions of section 24 of the Federal Deposit Insurance Act ("FDI Act"), 12 U.S.C. § 1831a, Merchants & Planters' Bank, Newport, Arkansas ("Bank"), has filed an application with the Federal Deposit Insurance Corporation ("FDIC"). The Bank requests the FDIC's consent to initiate the activity of indirectly engaging in equity real estate investment activities through Three Rivers Realty, Inc. ("Subsidiary"), a wholly-owned subsidiary of the Bank.
The activity of acquiring and developing real estate for investment purposes may not be a permissible activity for a national bank or a subsidiary of a national bank. State-chartered FDIC-insured banks may not engage as principal in an activity prohibited to nationally-chartered banks unless they obtain consent from the FDIC. Consent may not be granted 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.
Arkansas State law empowers state banks to hold, purchase, convey, mortgage, and lease real property, under specific circumstances and limitations. Those powers permitted to banks may be conducted through one or more subsidiaries. In April 1990, the Bank Commissioner for the State of Arkansas granted permission to the Bank to establish the Subsidiary to conduct real estate-related activities. Since inception, the Subsidiary has been engaging exclusively in the disposition of Bank assets acquired from debts previously contracted ("DPC"). The types of DPC real estate activities managed through the Subsidiary consist principally of: 1) renovation, lease, and resale of small apartment complexes; 2) fix-up and resale of single family dwellings; and 3) sale of developed lots.
The Bank requests consent from the FDIC to engage in an activity of a type not closely related to banking, specifically, in the acquisition and development of real estate for investment purposes, up to a maximum aggregate investment outstanding at any one time of $200,000. The types of local real estate investment activities in which the Subsidiary would like to invest are: 1) the acquisition of land and/or existing improved property for development into commercial or retail facilities for lease and/or sale; 2) the acquisition of land for development of small multi-family (more than four) dwelling units or of existing units for renovation for leasing purposes and resale; and 3) participation in other local community improvement projects which may not be specifically permitted by Part 362 but which would provide a local community service, nonetheless (i.e., building airplane hangars of a permanent nature for the local airport). All real estate investment activities would conform to the restrictions or limitations of State law.
Investments in real estate, at any stage of the development process or even completed properties, can be generally 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 1980's and early 1990's, and the impact of that downturn on financial institutions, provides an illustration of the market risk presented by real estate investment. 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 risk is higher than for most traditional bank assets, such as loans or debt securities. Real estate investment 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. In addition, real estate investment is of questionable benefit in the diversification of a financial institution's portfolio of assets. 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 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.
The Board of Directors ("Board") of the FDIC has reviewed available information and has also taken into consideration the financial and managerial resources and future earnings prospects of the Bank. The Board also considered the risks associated with real estate investment activities. In determining if a significant risk to the deposit insurance fund exists in the proposal, the Board evaluated the specifics of the Bank's application. In evaluating an equity real estate investment activity application pursuant to Part 362 of the FDIC's Rules and Regulations, 12 C.F.R. Part 362 ("Part 362"), the Board considers the types of real estate investment activity proposed to determine if any activity is unsuitable for an insured depository institution. The proposed subsidiary structure and its management policies and practices are reviewed to determine if a bank is adequately protected from litigation risk. Capital adequacy is analyzed to ensure that a bank first devotes sufficient capital to its more traditional banking activities. Capital adequacy is determined by a bank's "consolidated" and "bank only" leverage and risk-based capital ratios, with all investments in real estate investment subsidiaries excluded from capital in the "bank only" capital calculation. Limitations on investment in a subsidiary engaging in real estate investment activities are evaluated in order to assure that the maximum risk exposure is nominal. Policies relating to extensions of credit to third parties for subsidiary-related transactions are evaluated to determine if they protect the bank from concentrations of risk. A bank's policies on engaging in transactions in which insiders are involved are reviewed to determine if they protect the bank from potential insider abuse. A bank's 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 are reviewed to determine if they prevent undesirable tying relationships and to determine if they are adequate to ensure that sound credit underwriting is maintained. Having reviewed these areas, the Board is imposing conditions for prudential reasons due to the volatility and other risks which are inherent to real estate investment activities, as well as to mitigate any potential insider conflicts of interest and to reduce risk to the deposit insurance fund.
The Bank is in compliance with applicable capital standards. The Bank states in its application that its investment in the proposed equity real estate investment activity subject to section 24 of the FDI Act will be limited to an aggregate outstanding amount not to exceed $200,000 and to those real estate investment activities described hereinabove. In order to ensure the Bank's capital is sufficient to support both traditional banking activities and equity real estate investment activities, the FDIC will also require that the Bank's capital, after deducting the Bank's aggregate investment in all equity real estate investment activities conducted through the Subsidiary and subject to Part 362, equal or exceed the level required for a "well capitalized" institution pursuant to section 325.103(b)(1) of the FDIC's Rules and Regulations.
In order to promote the concept that real estate investment activities should be conducted in a separately. and adequately capitalized subsidiary and to ensure that the appropriate deposit insurance fund is adequately compensated for, and sufficiently protected from, additional risk in the event that "bank only" capital levels fall below "well capitalized" levels, the Bank's capital category for purposes of Prompt Corrective Action will be determined, and the Bank's risk-adjusted deposit insurance premium will be assessed, based on "bank only" capital ratios, except that such deductions shall not be made when determining whether the Bank is "critically undercapitalized" as defined under Part 325.
Given the high risk present in real estate investment activities, the Board has also imposed a condition requiring that transactions between the Bank and the Subsidiary engaging in real estate investment activities shall be made in accordance with the restrictions of sections 23A and 23B of the Federal Reserve Act to the same extent as though the Subsidiary were an affiliate of the Bank as defined under sections 23A and 23B, with the exception that the collateral requirements and investment limitations of section 23A shall not apply to loans made by the Bank to finance bona fide sales of assets to third parties provided: 1) any such loans are consistent with safe and sound banking practices; 2) do not involve more than the normal degree of risk of repayment; and 3) the loans 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. Any such loans made by the Bank will be reviewed by examiners at each regular safety and soundness examination conducted by the FDIC.
For the reasons outlined above, including the imposition of conditions, the Board of Directors has concluded that the proposed limited conduct of real estate investment activities through the Subsidiary does not pose a significant risk to the Bank Insurance Fund, provided certain conditions are observed, and therefore approval of the application, subject to conditions in the Order, is warranted.
THE BOARD OF DIRECTORS
FEDERAL DEPOSIT INSURANCE CORPORATION