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  4. Board Rulings and Staff Opinions Interpreting Regulation W and Federal Reserve Act Sections 23A and 23B

Board Rulings and Staff Opinions Interpreting Regulation W and Federal Reserve Act Sections 23A and 23B

3-1186

AFFILIATES TO WHICH APPLICABLE—Affiliate Receiving Loan Through Exempt Affiliate

A loan from a member bank to its affiliate falls within the limitations of section 23A even if made indirectly through another affiliate that is exempt from the limitations of section 23A. STAFF OP. of March 11, 1970.
Authority: FRA § 23A, 12 USC 371c.
3-1186.1

AFFILIATES TO WHICH APPLICABLE—Trust

A bank’s involvement in the creation of a trust and its exercise of control over the choice of an underwriter who will be authorized to choose the trustee represents an affiliate relationship between the trust and the bank under section 2(b) of the Banking Act of 1933. STAFF OP. of Jan. 29, 1976.
Authority: FRA § 23A, 12 USC 371c; Banking Act of 1933 § 2(b), 12 USC 221a(b).
3-1186.2

AFFILIATES TO WHICH APPLICABLE—Common Shareholders

Two banks or bank holding companies that have a common group of shareholders that own 25 percent or more of the voting shares of two banks or bank holding companies but who have no familial, contractual, or other relationship, are affiliates for purposes of section 23A.
Under subparagraph (b)(1)(C)(i), any company that is controlled by shareholders that control the member bank is an affiliate of the member bank. The statutory definition does not require that a familial, contractual, or other relationship exist between the shareholders in order that the company be deemed an affiliate; the only requirement is a commonality of ownership. Thus, any company that is owned by any group of shareholders that controls 25 percent of the voting shares of a bank is an affiliate of that bank for purposes of section 23A, even if no other relationship exists between the owners.
A trustee who controls the shares of a company in a trust must aggregate the shares that he or she controls as trustee with any additional shares owned in his or her individual capacity. The “control” and “affiliate” definitions of section 23A do not distinguish between shares that are controlled by a trustee in a fiduciary capacity and shares owned by the trustee in an individual capacity. In fact, subparagraph (b)(1)(C)(i) specifically includes in the definition of “affiliate” companies that are controlled “directly or indirectly, by a trust or otherwise . . . .” Thus, the shares that a trustee owns in a fiduciary capacity must be aggregated with the shares the trustee controls as an individual to determine if a company is an affiliate. Similarly, the shares that a beneficiary owns through a trust must be aggregated with the shares the beneficiary owns as an individual to determine if the affiliate relationship exists between the two entities, because “affiliate” includes companies that are controlled “by or for the benefit of shareholders who beneficially or otherwise control directly, or indirectly by trust or otherwise, the member bank.” STAFF OP. of Feb. 5, 1990.
Authority: FRA §§ 23A(b)(1)(C)(i), 12 USC 371c(b)(1)(C)(i).
3-1186.3

AFFILIATES TO WHICH APPLICABLE—Partnership and Association

Section 23A(b)(6) defines “company” to mean “a corporation, partnership, business trust, association, or similar organization.” The legislative history to this section does not elaborate on what this definition encompasses. However, it appears from the use of the phrase “association or similar organization” that Congress intended section 23A to apply to individuals joining together for a business purpose, regardless of whether corporate formalities are observed.
The United States Supreme Court has explained in other contexts that “association” used in its “ordinary meaning . . . has been defined as a term ‘used throughout the United States to signify a body of persons united without a charter, but upon the methods and forms used by incorporated bodies for the prosecution of some common enterprise.’ ” Hecht v. Malley, 265 U.S. 144, 157 (1923) (citations omitted).
The Supreme Court also has stated that “ ‘[a] ssociation’ implies associates. It implies the entering into a joint enterprise, and . . . an enterprise for the transaction of business. . . .  While the use of corporate forms may furnish persuasive evidence of the existence of an association, the absence of particular forms, or of the usual terminology of corporations, cannot be regarded as decisive.” Morrissey v. Commissioner of Internal Revenue, 296 U.S. 344, 356, 358 (1935).
Given the purpose of section 23A, it is appropriate to apply the statute to a body of persons united for a business purpose but without a charter in order to protect banks from the misuse of financial transactions with affiliates.
It is clear that section 23A applies to partnerships. The statute does not, however, distinguish formal from informal partnerships. Accordingly, a business relationship that is recognized as a partnership by the laws of the state where the partnership is located is subject to section 23A. STAFF OP. of April 20, 1990.
Authority: FRA § 23A, 12 USC 371c(b)(6).
3-1186.4

AFFILIATES TO WHICH APPLICABLE—Foreign-Exchange Fund

A state member bank proposes to organize and advise a foreign-exchange fund. The purpose of the fund would be to provide a pooled investment vehicle to invest solely in long and short positions in spot and forward foreign-exchange contracts and short-term money market instruments, which the bank may invest in directly.
The fund would be organized as a corporation under the laws of the Cayman Islands. All of the voting shares of the fund would be held in trust by an unaffiliated trust company located in the Cayman Islands. A charitable organization would be the beneficial owner of the voting shares. This ownership arrangement is used to avoid having the investments held by the fund viewed as assets of the bank.
The fund would also issue nonvoting shares, no more frequently than one a year, to a limited number (less than 100) of very sophisticated investors, most of whom would be non-U.S. persons, so that the fund would not be subject to the registration and other requirements of the Investment Company Act.
The bank’s primary role would be to serve as investment advisor to the fund. The bank would also assist in privately placing the fund’s shares with investors so that the fund’s shares will not be subject to the registration requirements of the Securities Act of 1933. The fund will execute trades with the bank, which will simultaneously execute the trades in the market.
The fund will be treated as an affiliate of the bank for purposes of sections 23A and 23B of the Federal Reserve Act. For purposes of the risk-based capital standards, the fund would be treated as a third party for capital-adequacy purposes.
The staff would not object to the bank’s conduct of these activities. STAFF OP. of July 24, 1990.
3-1187

COLLATERAL—Stock Valuation

The “book value,” that is, total capital funds excluding loan-loss valuation reserves, of a relatively small bank is a conservative estimate of a bank’s value in the marketplace and, as such, is a reasonable basis upon which to assess the market value of the stock when determining collateral requirements for purposes of section 23A. STAFF OP. of June 7, 1978.
Authority: FRA § 23A, 12 USC 371c; 12 CFR 223.14(b)(1)(iv).
3-1187.1

COLLATERAL—Stock Valuation

Section 23A of the Federal Reserve Act requires that shares pledged as collateral for a loan by a bank to its affiliate have a market value of at least 120 percent of the amount of the loan. When a stock is traded in the over-the-counter (OTC) market, the OTC market price is readily ascertainable and would serve as the market value for purposes of section 23A. However, when a stock is not actively traded and, therefore, has no readily ascertainable market value, the Board staff will look at other indicators to approximate a market value for that stock. STAFF OP. of March 22, 1979.
Authority: FRA § 23A, 12 USC 371c.
3-1187.2

COLLATERAL—Stock Valuation

For purposes of section 23A, the market value of shares may be determined by either the over-the-counter bid or asked price or the final market price for the day. STAFF OP. of April 9, 1979.
Authority: FRA § 23A, 12 USC 371c.
3-1188

“COVERED TRANSACTION”—Purchase of Assets

A member bank’s purchase, on a nonrecourse basis, of a loan or participation in a loan made to an unaffiliated third party from a nonbank affiliate would be considered a purchase of assets from the affiliate under section 23A(b)(7)(C). The transaction may not involve the purchase of a low-quality asset and must be on terms that are consistent with safe and sound banking practices. In addition, section 23B of the Federal Reserve Act (12 USC 371c-1) requires that transactions between a member bank and its affiliate be on terms at least as favorable to the bank as comparable transactions with third parties.
If a member bank purchases a loan that represents an extension of credit to an affiliate, the extension of credit must be collateralized pursuant to the requirements in section 23A(c), regardless of whether the member bank purchased the loan from an affiliate or from an unrelated third party because, after the transaction, the affiliate has an obligation to repay the extension of credit to the member bank. Thus, if the extension of credit that a bank purchases from an affiliate represents an extension of credit to any affiliate of the bank, then the bank’s purchase of this loan or participation in a loan would have to comply with the quantitative limits and collateral requirements of section 23A.
If a bank purchased a loan or participation from an affiliate on a recourse basis, then the transaction would be deemed to be an extension of credit to the affiliate because the affiliate would be contingently liable to the bank. The purchase of a loan on a recourse basis by a member bank from an affiliate should be adequately collateralized under section 23A (c).
Clarification was also requested regarding the treatment of the purchase of assets under Board interpretation 12 CFR 250.250.* This interpretation continues to be relevant to determining whether a member bank has engaged in a covered transaction with an affiliate. Prior to the 1982 amendment of section 23A by the Garn-St Germain Act, a bank’s discount of a promissory note from an affiliate was defined as a loan or extension of credit under section 23A. After the Garn-St Germain amendment to section 23A, the statute treats this transaction as a purchase of assets, subject to the quantitative limitations, but not the collateral requirements, of section 23A. Accordingly, a member bank will not be deemed to have purchased an asset from an affiliate if the criteria of the Board’s interpretation 12 CFR 250.250 are satisfied, including the requirement that a bank’s purchase of assets from an affiliate may not be used to finance the activities of the affiliate. STAFF OP. of May 2, 1990.
Authority: FRA § 23A(b)(7), 12 USC 371c(b)(7); 12 CFR 223.42(k).
*
This interpretation has been rescinded and its provisions incorporated into section 223.42(k) of Regulation W.
3-1188.1

“COVERED TRANSACTION”—Acceptance of Securities

Bank A, Bank B, and Bank C are affiliates for purposes of section 23A because of common ownership by a family. Bank A extended two loans to an individual to finance 100 percent of the purchase price of an original issue of preferred stock of Bank B. This loan was secured by the shares of preferred stock of Bank B that the individual purchased with the loan from Bank A. Bank A extended another loan to another person, which was used to purchase newly issued shares of Bank C. This person used the shares of Bank C to secure the loan from Bank A.
In addition to regulating direct transactions between a bank and its affiliate, section 23A(a)(2) provides that “any transaction by a member bank with any person shall be deemed to be a transaction with an affiliate to the extent the proceeds of the transaction are used for the benefit or transferred to that affiliate.” The staff was asked whether the loans from Bank A that are secured by the newly issued shares of an affiliate bank should be treated as the “acceptance of securities issued by the affiliate as collateral security” and thus subject only to the quantitative requirements of section 23A(b)(7)(D) or whether, because the proceeds of the loan were transferred to the affiliate, the transaction should be viewed as a loan to an affiliate and thus subject to the quantitative and collateral requirements of section 23A(c)(1).
The loans from Bank A should be treated as loans to the affiliated banks and thus subject to the collateral as well as the quantitative requirements of the statute. In this case, the proceeds of the loans from Bank A were transferred to the affiliated banks, Bank B and Bank C, when the individuals purchased the newly issued shares from the banks. Because these transactions involved extensions of credit and Bank A knew that the loan proceeds were being transferred to an affiliate, these transactions should be treated as loans to the affiliates and not as “the acceptance of securities issued by an affiliate.” Moreover, once the transactions are deemed “loans” for purposes of section 23A, they must be secured pursuant to the statute’s collateral requirements and the securities issued by any affiliate may not be used as security for a loan to an affiliate (12 USC 371c(c)(4)).
A loan that is secured by an affiliate’s securities is not treated as a loan to an affiliate only when the proceeds are not being transferred to or used for the benefit of an affiliate. When the loan proceeds are not transferred to an affiliate, the loan is treated as a separate type of covered transaction pursuant to section 23A(b)(7)(D) and is not subject to the statute’s collateral requirements. STAFF OP. of March 4, 1994.
Authority: FRA § 23A, 12 USC 371c.
3-1188.2

“COVERED TRANSACTION”—Issuance of a Guarantee

The execution of a cross-default agreement by an insured depository institution on behalf of its uninsured affiliate represents the issuance of a guarantee that is subject to the quantitative and collateral requirements of section 23A. Accordingly, insured depository institutions may not enter into such agreements on behalf of an uninsured related entity if the potential liability of the agreement would exceed the quantitative limits imposed on the insured institution by section 23A. In addition, any cross-default agreement that an insured depository institution enters into on behalf of an affiliate would need to be secured by collateral in the amounts set forth in the statute. BD. RULING of March 29, 1994.
Authority: FRA § 23A, 12 USC 371c(b)(7)(E) and 371c(c).
3-1189

EXEMPTIONS—Privately Issued Collateralized Mortgage Obligations

Privately issued collateralized mortgage obligations (CMOs) that are secured by mortgage-related securities issued or guaranteed by GNMA, FNMA, or FHLMC are not obligations of the United States or its agencies or obligations fully guaranteed by the United States or its agencies as to principal and interest, and thus are not eligible for exemption from the quantitative limitations of section 23A of the Federal Reserve Act pursuant to section 23A(d)(4)(A) or (B).
This treatment of these privately issued CMOs is consistent with the Board’s treatment of similar obligations for purposes of other provisions of the Federal Reserve Act. For example, section 201.108 of the Board’s Regulation A lists securities that the Board has previously determined to be obligations of, or that are fully guaranteed as to principal and interest by, the United States or its agencies for purposes of section 14(b) (governing eligibility for purchase by Reserve Banks) and section 13 (governing eligibility as collateral for advances). Similarly, such CMOs do not qualify as fully guaranteed obligations of the United States for purposes of the reserve requirements. Regulation D, governing reserve requirements of depository institutions, excludes from its definition of “deposit” an obligation that “arises from a transfer of direct obligations of, or obligations that are fully guaranteed as to principal and interest by, the United States government or any agency thereof that the depository institution is obligated to repurchase” (12 CFR 204.2(a) (1)(vii)(B)). CMOs issued by a private trust secured by mortgage-related securities issued by GNMA, FNMA, or FHLMC are not eligible for this exemption to Regulation D.
Therefore, a pledge of CMOs by a holding company to secure a loan to the mortgage subsidiary would not exempt the loan from the quantitative provisions of section 23A. The amount of collateral required for the loan will be based upon the collateral provisions of section 23A(c). If collateral consists solely of the CMOs, the market value of the collateral must equal at least 120 percent of the amount of the loan (12 USC 371(c)(1)(C)). STAFF OP. of June 13, 1990.
Authority: FRA § 23A(d)(4)(A) and (B), 12 USC 371c(d)(4)(A) and (B); FRA § 23A (c)(1)(C), 12 USC 371c(c)(1)(C).
3-1190

“EXTENSION OF CREDIT”—Government National Mortgage Association Certificate of Guarantee

Section 23A limits a member bank’s loans to and investments in its affiliates in order to ensure that the bank’s resources are not used for the benefit of organizations under common control of the bank. Section 23A would not apply whenever an affiliate, acting as an agent, takes title to mortgages in a bank’s portfolio solely to facilitate the issuance of a certificate of guarantee by the Government National Mortgage Association (GNMA). Such a relationship should be clearly defined and supported by appropriate documents that ensure that the principal bank’s interests in the mortgages are preserved. Such documents should include an assignment to the bank of the right to receive the GNMA certificate of guarantee and interest and principal payments on the mortgages during the interim period of application and issuance of the certificate. Under these circumstances, the section 23A concerns for the misuse of the bank’s resources to benefit an affiliate are not present because the affiliate receives title to the mortgages merely as an agent acting for the benefit of its principal, the bank. Such a transaction is not an extension of credit to an affiliate, nor is it an investment in obligations of the bank’s affiliate, since the mortgage-backed securities represent obligations of the mortgagors that are guaranteed by GNMA. STAFF OP. of Sept. 21, 1977.
Authority: FRA § 23A, 12 USC 371c.
3-1190.1

“EXTENSION OF CREDIT”—Equipment Lease Agreement

If an equipment lease agreement is essentially a financing arrangement, it may be considered the equivalent of a loan or extension of credit pursuant to section 23A of the Federal Reserve Act. The following combination of factors are evidence of such a financing arrangement: (1) the agreement contains a UCC financing statement of the type normally filed in connection with a secured credit transaction, (2) many attributes of ownership of the equipment, such as responsibility for servicing, insuring, licensing and assumption of risk of loss, pass to the lessee, (3) the lessee has the right to purchase the equipment at the end of the lease period, and (4) the useful life of the equipment is of such a short duration that the lessor must look to the terms of the agreement, rather than to the equipment’s resale value, as the primary source of recovery for his investment. STAFF OP. of Dec. 5, 1977.
Authority: FRA § 23A, 12 USC 371c.
See also BHCA § 4, 12 USC 1843; 12 CFR 225.4(6)(i)(a).
3-1192

LOW-QUALITY ASSETS—Open-End Credit Card Account

The definition of “low-quality asset” is applicable to all covered transactions and does not distinguish between open-end credit card accounts and other types of transactions. Thus, any type of account that is 30 days past due would be considered a low-quality asset under subsection (b)(10)(C) of section 23A. The Board’s policy statement on the classification of consumer installment credit defines when an open-end credit card account is 30 days past due. The policy statement defines an open-end credit card account with two zero billings as 30 days delinquent. Thus, if a debtor missed one payment but subsequent payments were made as scheduled and when required, the account would not be considered a low-quality asset. Moreover, even if the debtor missed payment for two billing cycles and the account became a low-quality asset, once subsequent payments were made as scheduled, the account would no longer be considered a low-quality asset. STAFF OP. of June 19, 1984.
Authority: FRA § 23A(b)(10)(C), 12 USC 371c(b)(10)(C).
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