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4000 - Advisory Opinions

Regulation O: Proposed Refinancing of Mixed Purpose Loan


July 20, 1993

Stephen L. Rodgers, Regional Attorney

Your Letter to Regional Counsel Sheldon J. Reisman, dated March 12, 1993, requesting advice as to the application of Regulation O to a loan proposed to be made by your client, [Bank A], has been referred to me for attention and reply.

The relevant facts regarding the proposed loan can be summarized as follows: Mr. [X], president of [Bank A] (which is a wholly-owned subsidiary of [Bank Holding Company]), and also president of the [Bank B], 52% of the stock of which is owned by [Bank A], desires to borrow the sum of $50,000 to finance an addition to his home. Mr. [X] presently has a first mortgage loan from [Bank A] in the amount of $88,000 (part of the proceeds of which were used for purposes other than the purchase, construction, maintenance or improvement of his personal residence), and a personal loan in the amount of $7,000 from [Bank B], which is secured by a pledge of stock of another financial institution. Your letter proposes that the addition to Mr. [X]'s residence might be accomplished by [Bank A] refinancing its existing first mortgage loan, with a $50,000 increase in the amount thereof; in the event refinancing by [Bank A] is found to violate Regulation O, you propose as an alternative that [Bank B] might make a second mortgage loan in the amount of $50,000.

The financing proposals set forth in your letter raise several issues under Regulation O. We have considered these issues and, where appropriate, have discussed them with the FDIC Legal Staff in Washington D.C. and with the Legal Staff of the Federal Reserve. For the purposes of this letter, we have assumed the accuracy of all facts which you have presented, and have further assumed that all loans made, or to be made, by [Bank A] or [Bank B] are, or will be, in conformance with various requirements of Regulation O which are not specifically discussed in your letter of inquiry or addressed below. This letter does not consider or take any position with regard to the impact of section 24 of the Federal Deposit Insurance Act, 12 U.S.C. § 1831a, on the ownership by [Bank A] of 52% of the stock of [Bank B]; we understand that the New York Regional Office's Division of Supervision is addressing that issue.

A threshold issue raised by your letter is whether [Bank A] and [Bank B] can be treated in all cases as two separate entities for purposes of Regulation O. Your letter takes the position at several points, and asks us to conform, that [Bank A] and [Bank B] are to be treated as separate entities. We do not agree that [Bank A] and [Bank B] can be treated as separate entities. 12 C.F.R. § 215.2(i) provides that a member bank includes any subsidiary thereof; section 337.3(c)(5) adopts such rule with respect to the subsidiaries of nonmember banks. That Mr. [X] holds an executive officer position with each institution (i.e., he is the president of each bank), accentuates this. Consequently, while extensions of credit by each bank must individually comply with Regulation O, any loans made by [Bank B] must also be added to loans by [Bank A] for purposes of the Regulation O requirements, since [Bank B] is a subsidiary of [Bank A]. Thus, for example, Mr. [X] could not borrow $70,000 from [Bank A] and $40,000 from [Bank B] under the authority of 12 C.F.R. § 215.5(c)(3) and 12 C.F.R. § 337.3(c)(2).

A second issue presented by your letter concerns whether the first proposed loan structure, under which [Bank A] would refinance its first mortgage loan to Mr. [X], with an increase in the loan amount from $88,000 to $138,000, is permissible under Regulation O. We assume initially that the proceeds of both the original loan and the loan increase are used solely for those housing-related purposes permissible under 12 C.F.R. § 215.5(c)(2), deferring until below consideration of issues which arise where part of the proceeds are not so utilized. We conclude that such refinancing is permissible under Regulation O. The outstanding $7,000 personal loan from [Bank B] to Mr. [X] would not ordinarily affect this conclusion, since that loan was made pursuant to a different section of the statute and implementing regulations than the housing-related loan which is to be refinanced. However, as will be discussed below, the fact that certain of the proceeds of the $88,000 first mortgage loan were used for purposes other than the purchase, construction, maintenance, or improvement by Mr. [X] of his personal residence, drastically changes this conclusion.

While section 22(g) of the Federal Reserve Act, 12 U.S.C. § 375a, does not include a specific requirement that the proceeds of a first mortgage loan to an executive officer be used for housing-related purposes, such a requirement is explicit in the implementing regulations. See 12 C.F.R. § 215.5(c)(2), providing that credit may be extended "in any amount to finance the purchase, construction, maintenance, or improvement of the residence of the executive officer. . . ." Accordingly, the use of any portion of the loan proceeds for purposes other than the purchase, construction, maintenance, or improvement by Mr. [X] of his personal residence takes the entire loan out of section 215.5(c)(2) and requires that it be made under the auspices, and subject to the limitations, of section 215.5(c)(3). Thus, the $88,000 first mortgage loan is under the authority of 12 C.F.R. § 215.5(c)(3), and must be combined with the $7,000 personal loan, giving a total of $95,000.

A final question asked by your letter is whether, in the event a refinancing by [Bank A] is found to violate Regulation O, an alternative might be utilized, in which [Bank B] would extend a personal "other purpose" loan under 12 C.F.R. § 337.3(c)(2) for the $50,000 construction costs. On the facts given, a $50,000 "other purpose'' loan to Mr. [X] by [Bank B] would be added to the $95,000 outstanding (as discussed above) and would result in a violation of 12 C.F.R. § 215.5(c)(3) and 12 C.F.R. § 337.3(c)(2).

In conclusion, based upon the facts you have presented, it appears that in order to accomplish the financing of the addition to Mr. [X]'s residence and comply with Regulation O, Mr. [X] must first repay, from other sources, the portion of the existing first mortgage loan which was not utilized for housing-related purposes, leaving on the bank's books an outstanding first mortgage loan balance, all of which has been used for housing-related purposes. Mr. [X] may then refinance such qualifying loan with [Bank A] (or [Bank B]), using all of the proceeds of the refinanced loan for the purchase, construction, maintenance or improvements of his residence.

The opinion expresses herein represents the current thinking of the FDIC Legal Division Staff. Like all staff opinions, the opinion expressed herein is not binding on the FDIC or its Board of Directors and is simply advisory in nature. If you have any further questions concerning this matter, you may write or call me at (212) 704-1200.

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