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4000 - Advisory Opinions

Extension of Credit in Correspondent Bank Relationship


May 5, 1980

Barbara I. Gersten, Attorney

This responds to your letter of February 19, 1980, to Dallas Regional Director Quinton Thompson requesting an opinion by the FDIC Legal Division whether an extension of credit as described in your letter is in violation of Title VIII of the Financial Institutions Regulatory and Interest Rate Control Act of 1978 ("FIRIRCA").

You indicated that *** Bancorporation owns the capital stock (exclusive of directors' qualifying shares) of *** ("Bank"). ***, a wholly-owned subsidiary of *** Bancorporation, owns 51,005 shares of the 396,000 shares issued and outstanding of *** Bancorporation. *** has a loan at a 6% interest rate secured by the *** Bancorporation stock from a national bank that is a correspondent of the Bank.

In support of your position that the foregoing does not present a Title VIII violation, you argue that every shareholder receives an equal benefit from the 6% interest rate (or detriment if the rate were higher). The low interest rate may also permit the payment of larger dividends to *** Bancorporation, for *** benefit as a shareholder. Smaller principal and interest payments allow for an increase in *** capital which contributes to soundness and enhances stockholder equity.

Title VIII, in pertinent part, prohibits preferential lending by a bank to principal shareholders of another bank when a correspondent relationship exists between the banks. Importantly, for Title VIII to apply, the extension of credit must have been made after the March 10, 1979 effective date of the statute, or must have been made before that date and be subject to renewal. Such renewable extensions of credit are treated as new extensions of credit at the time of renewal, and must comport with Title VIII.

A "principal shareholder" is one who directly or indirectly owns, controls, or has the power to vote more than 10% of the bank's stock. The term would include a nonbank company or individual that "controls" a principal shareholder (in this case a person who controls *** Bancorporation). The term "control of a company", as defined in Federal Reserve Regulation O (12 C.F.R. § 215.(b)), would apply here. In general, "control'' is defined as ownership, control or the power to vote 25% or more of any class of voting securities of the company; or the power to exercise a controlling influence over the company's management or policies; or control (in any manner) of the election of a majority of the company's directors. Importantly, "control" is presumed where a person directly or indirectly owns, controls or has the power to vote more than 10% of any class of voting securities of the company, and no other person owns, controls, or has the power to vote a greater percentage of that class of voting securities.

A loan is "preferential" for the purposes of Title VIII if (1) it is not made on substantially the same terms (including interest rate and collateral) as those prevailing at the same time for comparable transactions with others not covered by Title VIII, (2) involves more than the normal risk of repayment, or (3) presents other unfavorable features.

Your letter does not state when the *** loan was made. Assuming it was made after March 10, 1979, or has been renewed since then, the following applies. From the facts as stated, *** Corporation is the principal shareholder of the Bank. Bancorporation's wholly-owned subsidiary *** is also presumed to be a principal shareholder of the Bank by virtue of its ownership of 14% of the stock of Bancorporation, assuming no other shareholder owns, controls, or has the power to vote a greater percentage of Bancorporation stock. (A presumption of control may be rebutted by submitting written evidence which demonstrates an absence of control.) If *** controls the election of a majority of Bancorporation's directors or otherwise exercises a controlling influence over Bancorporation's management or policies, then *** also may be a principal shareholder of the Bank on these grounds. If *** is found to be a principal shareholder of the Bank through its control of *** Bancorporation, then the prohibitions of Title VIII would apply to loans it receives from the Bank's correspondent banks.

*** is also a related interest of Bancorporation. While Title VIII does not expressly prohibit preferential extensions of credit to a related interest (i.e., controlled company) of a principal shareholder, if it can be shown that the principal shareholder received a direct, tangible economic benefit from the extension of credit to its related interest, the extension of credit may be deemed to have been made to the principal shareholder and is therefore subject to the Title VIII prohibitions. The fact that the loan to *** at a 6% interest rate results in the payment of higher dividends to Bancorporation, is not, in and of itself, considered to be such a direct, tangible economic benefit. It is not apparent whether there are any direct benefits to Bancorporation that would trigger application of the Title VIII prohibitions to the loan to *** regardless of whether or not *** is determined to be a principal shareholder of the Bank by virtue of its 14% ownership of Bancorporation.

Title VIII prohibits only preferential lending. Any determination of whether a loan is preferential is based upon the statutory standard which requires that the loan in question be compared with a similar class of transactions. In this particular case, the comparable class of transactions would be loans made to corporate entities not covered by Title VIII for the same purpose as the loan to ***. Any potential benefit or detriment to shareholders as a result of the loan is not considered in making this determination.

If *** is considered a principal shareholder of the Bank by virtue of its control of Bancorporation, or if Bancorporation, as a principal shareholder of the Bank, is found to have received a direct benefit from the *** loan, then a determination must be made whether the loan to *** is preferential. The terms and conditions of the *** loan are not set forth in detail, and no information about comparable loans by the Bank's correspondent has been provided. Absent this, we are unable to definitely determine whether the *** loan is preferential.

Importantly, whether or not the subject loan presents a Title VIII violation because it is a preferential loan to a principal shareholder, the potential does exist for a violation of section 656 of the U.S. Criminal Code (18 U.S.C. § 656). That statute provides, in pertinent part, that anyone connected in any capacity with an insured bank who willfully misapplies the bank's funds, is subject to a fine of not more than $1,000 and/or imprisonment for one year. Section 656 might apply to either *** (because of its possible control of Bancorporation) or Bancorporation (because of its control of the Bank), or both. A section 656 violation may be found where, for example, one who controls a bank has caused the bank to maintain a compensating balance with its correspondent in return for a loan from the correspondent at a preferential interest rate, and the correspondent either does not perform the usual banking services for the bank or the services performed do not justify the income earned on the account by the correspondent bank. Where a possible section 656 violation is found, the matter is referred to the United States Attorney for appropriate action.

Should you have any questions regarding the substance of this opinion, please do not hesitate to contact me at 202-389-4422.

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