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4000 - Advisory Opinions

Section 23A--Insurance of Preferred Stock As a Consideration for a "Purchase" of Assets


October 23, 1989

Gerald J. Gervino, Senior Attorney

You have provided us with a copy of a legal opinion dated September 26, 1989, supplied by *** attorneys for the subject bank ("bank") concerning Section 23A of the Federal Reserve Act, 12 U.S.C. 371c ("Section 23A"). The opinion attempts to establish the exchange of credit card receivables for liquidation-preference preferred stock as outside the ambit of the term "purchase" contained in Section 23A(b)(7)(C) of the Federal Reserve Act.

You question this opinion and further ask us to provide an opinion as to whether or not the proposed exclusion of the low-quality assets from the calculation of the amount of stock to be issued removes the transaction from the coverage of the third paragraph of the definition of a "covered transaction." You also inquire about our historical policy of issuing interpretive letters with respect to Section 23A.

In our view, the term "purchase" contained in Section 23A(b)(7)(C) includes the issuance of preferred stock in exchange for credit card receivables transferred to the bank. The preferred stock presumably has a value to the holding company and can probably be sold for value to third parties. Thus, there appears to be consideration furnished by the bank and therefore a "purchase" of the credit card receivables by the bank within the meaning of Section 23A(b)(7)(C).

Bank counsel points out that the FDIC and the Comptroller of the Currency have "approved" similar transactions. The letters he has furnished us to support that proposition do not indicate agency "approval" of any transactions. The 1987 letter from our New York office deals with an interbank affiliation partially exempted by Section 23A(d). In the transaction presented here, the bank is purchasing from a parent that is not a bank and thus the partial Section 23A(d) exemption is not available. In his 1989 letter to counsel for an affiliate of counsel's client, another of our regional directors objected to the use of limited life preferred stock in an apparently similar transaction. While the letter did indicate "no objection" to certain unspecified facts relating to Section 23A, it is a supervisory comment letter and does not purport to be a legal opinion or a precedent.

You have also furnished us with a "Recent Corporate Decision" of the Office of the Comptroller of the Currency relating to the following situation: "Since the [credit card] portfolio was being purchased net of an adequate loan loss reserve and *** [parent of the selling affiliate] agreed to forgive that amount of the preferred stock's principal equal to any charge-offs exceeding the reserve, the Office [of the Comptroller of the currency] did not perceive any supervisory concerns. [Emphasis Supplied]. The opinion was issued in connection with an application involving the issuance of securities. It also involved a waiver of the Office's regulation with respect to minimum capital ratios. We do not receive applications concerning the issuance of capital, nor do we grant waivers from our capital maintenance regulations, except that where we find that exigent circumstances exist, we may permit debt obligations of shorter maturity to qualify as capital for purposes of 12 CFR Part 325.

The above opinion of the Office of the Comptroller of the Currency was provided with respect to a purchase of credit card receivables in exchange for limited life preferred stock in a face amount reduced by an adequate loan loss reserve. The security holder, *** agreed to forgive that amount of the preferred stock's principal equal to any charge-offs exceeding the reserve.

In our view, the *** transaction appears to be risk-free because the face amount of the preferred stock available for forgiveness should equal the book value of the purchased credit card receivables. The bank controls the original accounting entries and can realize on the "security" simply by failing to make payment to the security holder for amounts it indicates have been lost in excess of the loan loss reserve which has already been deducted.

You specifically ask if the segregation of low-quality assets from the remainder of the loan portfolio and the transfer to the bank without consideration of those low-quality assets would avoid the Section 23A prohibition on the purchase of low-quality assets. The transaction would include a prohibited purchase of low-quality assets. However, since the value of the "purchase" was nonexistent, the "violation" is technical and immaterial. Thus, it should not be raised or cited.

The FDIC has to our knowledge taken a no objection position with respect to the applicability of Section 23A to transactions incidental to insurance applications and merger-type applications. In these circumstances, the FDIC has the benefit of its own investigation of the transaction and has the power to object or prohibit any aspects of a transaction that may seem to present risky possibilities. The difficulty with following that procedure here is that the bank is only intending to issue 5 per centum of its preferred stock. Thus, ninety five per centum of the future "purchases" will be closed in an unregulated transaction. Under these circumstances, it would appear that we cannot give a no objection position for transactions where we have not carried on a statutory investigation. In this set of circumstances there is apparently no approval requirement in the Federal Deposit Insurance Act or in our regulations.

I have presented the facts in issue here to my counterparts at the Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency. They agree that the transaction is a "purchase" of the non-donated credit card receivables within the meaning of Section 23A.

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