Decisions on Bank Applications
FEDERAL DEPOSIT INSURANCE CORPORATION
RE: Beal Bank, s.s.b., Dallas, Texas
Application Pursuant to Section 24 of the Federal Deposit Insurance Act for Consent to Continue to Indirectly Engage as Principal Through a Wholly Owned Subsidiary in Real Estate Investment Activities That May Not Be Permissible for a National Bank
Pursuant to the provisions of Section 24 of the Federal Deposit Insurance Act ("FDI Act") Beal Bank, s.s.b., Dallas, Dallas County, Texas ("Beal") has filed an application with the Federal Deposit Insurance Corporation ("FDIC"). Beal requests the FDIC's consent to continue to indirectly engage in real estate investment activities through its wholly owned subsidiary, Beal Mortgage, Inc., ("BMI") which is involved in the "(1) acquisition of unimproved real estate lots and other unimproved real estate for the purpose of prompt development and subdividing; (2) purchasing, selling, owning, renting, leasing, managing, subdividing, improving, operating for income, or otherwise dealing in and with real property, whether improved or unimproved; (3) acquisition of improved residential real estate and mobile home lots to be held for sale or rental; (4) acquisition of improved real residential real estate for remodeling, rehabilitation, modernization, renovation, or demolition and rebuilding for sale or rental; and (5) maintenance and management of rental real estate".
The activities conducted through BMI may not be permissible activities 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 Beal is in compliance with applicable capital standards and the FDIC determines that the activity poses no significant risk to the deposit insurance fund. Section 77.93(a)(2) of the Rules and Regulations for Texas Savings Banks states subsidiary corporations of Texas Savings Banks are authorized to engage in certain pre-approved activities which include those undertaken by BMI. These authorized subsidiary corporation activities are similar to and consistent with those subsidiary corporation activities authorized for federal savings associations pursuant to 12 CFR Section 545.74(c)(3).
Since 1988, BMI has engaged in a wide range of activities but primarily in acquiring commercial and residential real estate acquired for the purpose of prompt development. Beal proposes to engage BMI in a wide range of real estate investment activities and the activities are within the parameters 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 FDIC has reviewed available information and has also taken into consideration the financial and managerial resources and future earnings prospects of Beal. The FDIC also considered the risks associated with real estate investment activities and the risks associated with developing, owning, and leasing of real estate by BHI. Beal is in compliance with applicable capital standards.
In determining if a significant risk to the fund exists in the proposal, the FDIC evaluated the specifics of Beal's application. In evaluating this application, the FDIC considered the types of real estate investment activities proposed to determine if any activities are suitable for an insured depository institution. The FDIC reviewed the proposed subsidiary structure and its management policies and practices to determine if Beal is adequately protected from litigation risk. Capital adequacy is analyzed to ensure that Beal first devotes sufficient capital to its more traditional activities. Capital adequacy was determined by Beal's "consolidated" and "bank only" leverage and risk-based capital ratios, with all investments in BMI excluded from capital in the "bank only" capital calculation. Limitations on investment in BMI were evaluated in order to assure that the maximum risk exposure is nominal. Beal's policies relating to extensions of credit to third parties for BMI-related transactions were evaluated to determine if they protect Beal from concentrations of risk. Beal's policies related to engaging in transactions in which insiders are involved were also reviewed to determine if they protect Beal from potential insider abuse. Beal's policies relating to the conditioning of loans on the purchase of real estate from Bill and the extending of credit by Beal to third parties for the purpose of acquiring real estate from BMI are reviewed to determine if they are adequate to ensure that sound underwriting credit is maintained. Having reviewed these areas, the FDIC is imposing conditions 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 interest and to reduce risk to the insurance fund.
As of December 31, 1994, Beal's investment of $3,005,215, including loans of $394,361 (as reflected on January 30, 1995) in BMI was 7.6 percent of Beal's equity capital, and Beal would continue to be in compliance with applicable capital standards even if the investment in BMI was deducted. Beal states that the expected volume or level of activity to be conducted by BMI will be a function of both capital and product availability. It is the intention of Beal to always maintain, after the investment in real estate is deducted from GAAP capital, a Tier 1 capital ratio above 6 percent. Due to the lack of specific information on the financial and other risks associated with real estate investment that BMI could potentially undertake, the FDIC has determined that it is appropriate to limit Beal to the level of real estate investment activity presently held or a level that does not reduce Tier 1 capital below 6 percent after deduction of the investment. Beal shall provide an Investment Plan to the FDIC's Regional Director for the Division of Supervision on an annual basis that indicates the extent of Beal's planned investments in BMI and any other real estate investment subsidiary and the manner in which concentration and diversification of risk issues within these real estate investment subsidiaries will be addressed. In considering Beal's engaging in additional real estate investment activities, the FDIC shall require that Beal's aggregate investment, including the proposed investment, in any one subsidiary not represent more than 10 percent of Tier 1 capital or reduce Tier 1 capital below 6 percent after deduction of the investment, and the total aggregate investment in all such subsidiaries represent no more than 20 percent of Tier 1 capital or reduce Tier 1 capital below 6 percent after deduction of the investment. Because the FDIC is limiting the activity of BMI to the 10 percent/20 percent limit discussed above, Beal may form an additional subsidiary without making full application to the FDIC under Section 24 provided that the limits and restrictions imposed by this action are observed and provided that the real estate investment activities of the additional subsidiaries are limited to those currently engaged in by BMI. In order to ensure Beal's capital is sufficient to support both traditional banking activities and real estate investment activities, the FDIC will also require that Seal's capital, after deducting Beal's aggregate investment, including the proposed real estate investment activity, in all Subsidiaries, equal or exceed the level required for a "well capitalized" institution pursuant to Part 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 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, Beal's capital category for purposes of Prompt Corrective Action will be determined and 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 Beal is 'critically undercapitalized.
Given the high risk present in real estate investment activities, the FDIC has also imposed a condition requiring that transactions between Beal and BMI shall be made in accordance with the restrictions of Sections 23A and 23B of the Federal Reserve Act to the same extent as though BMI were an affiliate of the Bank as defined under Sections 23A and 23B, with the exception that the collateral requirements and investment limitations of 23A shall not apply to loans made by Beal to finance bona fide sales of assets to third parties provided any such loans are consistent with safe and sound banking practice and do not involve more than the normal degree of risk of repayment and the loans are extended on terms and under circumstances, including credit standards, that are substantially the same, or at least as favorable to Beal, as those prevailing at the time for comparable transactions. Any such loans made by Beal would 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 continuation of activities through BMI does not pose a significant risk to the Savings Association Insurance Fund, provided certain conditions are observed, and therefore approval of the application, subject to the conditions in the Order, is warranted.
THE BOARD OF DIRECTORS FEDERAL DEPOSIT INSURANCE CORPORATION
FEDERAL DEPOSIT INSURANCE CORPORATION
RE: Beal Bank, s.s.b. Dallas, Texas
Application Pursuant to Section 24 of the Federal Deposit Insurance Act
The Board of Directors 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. S 1831a, and Section 362 of the Rules and Regulations, 12 C.F.R. S 362.4, relating to an application by Beal Bank, s.s.b., Dallas, Texas ("Beal"), for consent to continue to indirectly engage as principal through Beal Mortgage Incorporated ("BMI"), a wholly owned subsidiary, in activities that may not be permissible for a subsidiary of a national bank. The Board of Directors, having found that Beal is in compliance with applicable capital standards and that the activities to be continued do not appear to pose a significant risk, with certain conditions imposed, 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 Beal for consent to indirectly engage as principal through BMI, in 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 Beal and BMI shall take the necessary actions to establish, and BMI shall operate in a manner so as to ensure, a separate corporate existence as a majority owned subsidiary which:
(a) is adequately capitalized,
(b) is physically separate and distinct in its operations from the operations of Beal,
(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, contracts with Beal for any service on terms and conditions comparable to those available to or from independent entities, and
(f) conducts business pursuant to separate policies and procedures designed to inform customers and prospective customers of BMI that BMI is a separate organization from Beal, including the placement of specific language on any debt instrument or contract with a third party disclosing that Beal itself is not responsible for payment or performance;
(2.) That Beal's indirect real estate investment activities in BMI, including equity interests, debt obligations of the subsidiary held by the bank, bank 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 the subsidiary or making an investment in any investment in which the subsidiary has an interest (defined collectively as "Real Estate Investment"), shall be limited to those which are currently held, and Beal shall not make any additional Real Estate Investment in BMI without the prior written consent of the FDIC's Director of the Division of Supervision or the Director's designee. However, Real Estate Investment shall not include loans made by Beal to finance bona fide sales of assets which meet the requirements of paragraph 11(b);
(3.) That before considering approval for Beal to expand the level of real estate investment activities, the FDIC will require that Beal's Real estate Investment, including the proposed additional investment, in BMI shall not represent more than 10% of Tier 1 capital or reduce Tier 1 capital below 6% after deducting all the Real Estate Investment;
(4.) That before considering approval for Beal to engage in additional real estate investment activities, the FDIC shall require that Beal's capital level, after deducting all Real Estate Investments in BMI, equal or exceed the level required for a "welI capitalized" institution pursuant to Part 325.103(b)(1) of the FDIC's Rules and Regulations;
(5.) That Beal shall, on a quarterly basis, perform the capital adequacy calculations described in paragraph 4 for the purpose of ascertaining Beal's risk adjusted deposit insurance premium, and that in the event Beal falls below the level required for a well capitalized institution pursuant to Section 325.103(b)(1) of the FDIC's Rules and Regulations, Beal 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;
(6.) That henceforth, notwithstanding Parts 325 and 327 of the FDIC's Rules and Regulations, 12 C.F.R. Parts 325 and 327, Beal's capital category for purposes of prompt corrective action and risk adjusted deposit insurance premium shall be calculated based on Beal's capital after deducting the Real Estate Investments, except that such deductions shall not be made when determining whether Beal is "critically undercapitalized" as defined under Part 325;
(7.) That Beal shall continue to meet all applicable capital standards;
(8.) That any extensions of credit to any third parties' for the purpose of making a direct investment in BMI, or making an investment in any other investment in which BMI has an interest, or any acceptance of any debt obligation of or equity interest in BMI as collateral security for a loan or extension of credit to any third party by Beal shall be clearly disclosed to Beal's board of directors prior to approval of the extension of credit and documented in the board's minutes;
(9.) That prior to the consummation of a transaction between BMI and any of Beal's customers, any potential conflicts of interest be identified, be appropriately resolved, and be clearly disclosed to the board of directors and documented in the board's minutes;
(10.) That Beal not engage directly or indirectly through BMI in any real estate investment activity or other transaction with insiders or their related interests without the prior written consent of the FDIC's Director of the Division of Supervision or the Director's designee;
(11.) That Beal shall:
(a) Not condition any loan on the purchase or rental of real estate from BMI, and
(b) Not extend credit to any borrower to acquire real estate from BMI unless it is consistent with safe and sound banking practice and does not involve 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 Beal, as those prevailing at the time for comparable transactions;
(12.) That transactions between Beal and BMI shall be made in accordance with the restrictions of Section 23A and 23B of the Federal Reserve Act, 12 U.S.C. S371c and S371c 1, to the same extent an though BMI were an affiliate of Beal as defined under Sections 23A and 23B, with the exception that the collateral requirements and investment limitations of 23A would not apply to loans made by Beal to finance bona fide sales of assets to third parties consistent with safe and sound underwriting requirements contained in paragraph 11(b) above; and
(13.) That the consent granted herein is based on the facts and circumstances presented or otherwise known to the FDIC in connection with these requests. Beal shall notify the FDIC of any significant change in facts or circumstances. If the facts and circumstances change significantly, the Corporation shall have the right to alter, suspend, or withdraw its approval.
Dated at Washington, D.C. this day of , 1995
BY ORDER OF THE BOARD OF DIRECTORS
Jerry L. Langley Executive Secretary