Decisions on Bank Applications
Citizens Bank
FEDERAL DEPOSIT INSURANCE CORPORATION
IN RE: Citizens Bank Booneville, Arkansas
Application Pursuant to Section 24 of the Federal Deposit Insurance Act for Consent to Continue to Engage as Principal Through a Majority Owned Subsidiary in Real Estate 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 ("FDI") Act, Citizens Bank, Booneville, Arkansas (the "Bank"), has filed an application with the Federal Deposit Insurance Corporation ("FDIC"). The applicant requests the FDIC's consent to--continue to engage as principal in real estate investment activities through First Western Properties, Inc. (the "Subsidiary"), a wholly owned subsidiary of the Bank which owns, manages, and leases real estate properties held for investment purposes.
The activity of holding real estate investment properties 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, with certain conditions imposed, to the deposit insurance fund. Arkansas State law permits the holding of real estate investment properties by bank holding companies, banks, and bank subsidiaries.
Since 1986, the Subsidiary has purchased real estate properties for the purpose of renovating, leasing, and holding the foreclosed properties obtained from the Bank. More recently, the Subsidiary has purchased properties for investment purposes. The Bank intends to continue real estate investment activities related to foreclosure properties and to engage in additional real estate development and investment activities, on a limited basis, when both the community and the Bank benefit from the transaction, and the acquisition is 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 quite 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. 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 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 and the risks associated with owning and leasing the particular properties held by the Subsidiary. The Bank is in compliance with applicable capital standards.
In determining if a significant risk to the fund exists in the proposal, the Board evaluated the specifics of the Bank's application. In evaluating this application, the Board considered the types of real estate investment activity proposed to determine if the activity is suitable for an insured depository institution. The FDIC reviewed the proposed subsidiary structure and its management policies and practices to determine if the Bank is adequately protected from litigation risk. Capital adequacy is analyzed to ensure that the Bank first devotes sufficient capital to its more traditional banking activities. Capital adequacy was determined by the Bank's "consolidated" and "bank only" leverage and risk-based capital ratios, with all investments in the Subsidiary excluded from capital in the "bank only" capital calculation. Limitations on investment in the Subsidiary were evaluated in order to assure that the maximum risk exposure to the Bank is nominal. The Bank's policies relating to extensions of credit to third parties for Subsidiary-related transactions were evaluated to determine if they protect the Bank from concentrations of risk. The Bank's policies on engaging in transactions in which insiders are involved were also reviewed to determine if they protect the Bank from potential insider abuse. The 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 the Subsidiary were 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 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 June 30, 1995, the Bank's investment in the Subsidiary represented approximately 3.95 percent of the Bank's Tier 1 capital and 0.33 percent of the Bank's total assets. The Bank states in its application that its investment in the Subsidiary will be limited to 10 percent of its equity capital; however, no feasibility study, financial projections, and/or business plan regarding the conduct of the activity was submitted in the application. Due to the lack of specific information on the financial and other risks associated with real estate investment that the Subsidiary could potentially undertake, the Board has determined that it is appropriate to limit the Bank to the level of real estate investment activity presently held, and the Bank shall not make any additional real estate investments without providing the FDIC's Regional Director of the Division of Supervision 45 days notice. The Bank may proceed with the additional investment if the Regional Director has not objected to the proposal within the 45 day notice period. If the Regional Director objects, the Bank may in its discretion file an application pursuant to Part 362 of the FDIC's Rules and Regulations for consideration by the FDIC's Board of Directors. In addition, the Bank's aggregate investment, including any proposed additional investment, in the Subsidiary shall not represent more than 10% of Tier 1 capital, the investment limitation requested by the Bank.
In order to ensure the Bank's capital is sufficient to support both traditional banking activities and real estate investment activities, the FDIC will also require that the Bank's capital, after deducting the Bank's aggregate investment, including the proposed investment, in the Subsidiary, 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 before providing consent for the Bank to make additional real estate related investments.
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, 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.
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 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 any such loans are consistent with safe and sound banking practices 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 the Bank, as those prevailing at the time for comparable transactions. Any such loans made by the Bank 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 retention of interest in real estate 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
FEDERAL DEPOSIT INSURANCE CORPORATION
IN RE: Citizens Bank Booneville, Arkansas
Application Pursuant to Section 24 of the Federal Deposit Insurance Act for Consent to Continue to Engage as Principal Through a Majority Owned Subsidiary in Real Estate Activities That May Not Be Permissible for a Subsidiary of a National Bank
ORDER
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. § 1831a, and Part 362 of the FDIC's Rules and Regulations, 12 C.F.R. Part 362, relating to an application by Citizens Bank, Booneville, Arkansas (the "Bank"), for consent to continue to engage as principal through First Western Properties, Inc. (the "Subsidiary"), a wholly owned subsidiary, in activities that are not permissible for a subsidiary of a national bank. The Board of Directors, having found that the Bank is in compliance with applicable capital standards, and that the activity to be continued does not appear to pose, with certain conditions imposed, 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 continue to engage as principal through the Subsidiary 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 the Bank and the Subsidiary shall take the necessary actions to establish, and the Subsidiary 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 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 indirect real estate investment in the Subsidiary, 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 the Bank shall not make any additional Real Estate Investment in the Subsidiary without providing the FDIC's Regional Director of the Division of Supervision 45 days notice. The Bank may proceed with the additional investment if the Regional Director has not objected to the proposal within the 45 day notice period. If the Regional Director objects, the Bank may in its discretion file an application pursuant to Part 362 of the FDIC's Rules and Regulations for consideration by the FDIC's Board of Directors. For purposes of this Order, Real Estate Investment shall not include loans made by the Bank to finance bona fide sales of assets which meet the requirements of paragraph 11(b) below;
3. That the Bank's aggregate Real Estate Investment, including the proposed additional investment, in the Subsidiary shall not represent more than 10 percent of Tier 1 capital;
4. That the Bank's capital level, after deducting all existing and proposed Real Estate Investments in the Subsidiary, shall 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;
5. The Bank shall, on a quarterly basis, perform the capital adequacy calculations described in paragraph 4 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 Part 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;
6. 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 shall be calculated based on the Bank's capital after deducting all Real Estate Investments, except that such deductions shall not be made when determining whether the Bank is "critically undercapitalized" as defined under Part 325;
7. That the Bank 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 the Subsidiary, making an investment in any investment in which the Subsidiary has an interest, or any acceptance of any debt obligation of or equity interest in the Subsidiary as collateral security for a loan or extension of credit to any third party by the Bank shall be clearly disclosed to the Bank'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 the Subsidiary and any of the Bank'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 the Bank shall not engage directly or indirectly through the Subsidiary in any real estate investment activity or other transaction with insiders or their related interests without the prior written consent of the FDIC's Regional Director of the Division of Supervision;
11. That the Bank shall:
(a) not condition any loan on the purchase or rental of real estate from the Subsidiary, and
(b) not extend credit to any borrower to acquire real estate from the Subsidiary unless it is consistent with safe and sound banking practices 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 the 1~3nk, as those prevailing at the time for comparable transactions;
12. That transactions between the Bank and the Subsidiary shall be made in accordance with the restrictions of Section 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 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 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.
Dated at Washington, D. C., this day of , 1995.
BY ORDER OF THE BOARD OF DIRECTORS
Jerry L. Langley
Executive Secretary