# O

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| ## Comptroller of the Currency                                        |
|                                                                       |
| > Administrator of National Banks                                     |
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Washington, DC 20219

March 21, 2005 **Interpretive Letter #1024**

##### April 2005

##### 12 USC 375b

##### 12 CFR 215.4

Subject: Application of 12 U.S.C. Section 375b(2)(A) and 12 C.F.R.
Section 215.4(a)(1) to Renewals of Loans to Bank Insiders

Dear **\[ \]**:

This letter responds to your inquiry regarding an interpretive issue
arising under Regulation O. Specifically, the question is whether a bank
that renews an extension of credit to its insider violates section
22(h)(2)(A) of the Federal Reserve Act[^1] and the corresponding
provision of its implementing regulation, section 215.5(a)(1) of
Regulation O,[^2] if the renewal, though not made on preferential terms,
"involves more than the normal risk of repayment or presents other
unfavorable features."[^3] Consistent with the written position of the
Board of Governors of the Federal Reserve System ("FRB"), we conclude
that it does.

Regulation O imposes quantitative and qualitative restrictions on a
bank's loans and extensions of credit to its "insiders," which include
the bank's principal shareholders, directors and executive officers, as
well as companies controlled by such persons. The regulation defines an
extension of credit to include "a renewal of any loan."[^4] Among the
regulation's qualitative restrictions, section 215.4(a)(1) of Regulation
O sets forth requirements regarding "Terms and Creditworthiness,"
prohibiting the making of a loan or extension of credit to an insider
unless the loan:

> \(i\) Is made on substantially the same terms (including interest

rates and collateral) as, and following credit underwriting procedures

that are not less stringent than, those prevailing at the time for

> comparable transactions by the bank with other persons that are not
>
> covered by this part and who are not employed by the bank; *and*
>
> \(ii\) Does not involve more than the normal risk of repayment or
>
> present other unfavorable features.[^5]

Thus, on its face, Regulation O requires that any loan to a bank insider
must satisfy *both* tests set forth above: The loan must be
non-preferential *and* it must not present a greater-than-normal risk of
repayment or other unfavorable features. Unless both tests are met, a
bank's loan to its insider violates Regulation O. We believe that this
interpretation is dictated by the plain language of the regulation and
by the purposes of the underlying statute. Federal Reserve Board
precedent supports this interpretation. In a 1994 opinion, the General
Counsel of the FRB made clear that the renewal of an insider loan that
involves more than the normal risk of repayment or presents other
unfavorable features violates Regulation O.[^6]

We are aware, however, of two old OCC staff opinions that take the
position that "once an insider has been identified as posing a credit
weakness, \[a loan\] may be renewed only if a comparable troubled loan
to a non-insider would be renewed."[^7] These OCC letters thus appear to
conflate the two tests in section 215.4(a)(1) by taking the position
that a bank does not violate Regulation O by renewing a loan to an
insider that involves more than the normal risk of repayment unless the
loan renewal is also preferential. One of these letters premises this
conclusion on the rationale that the purpose of Regulation O is to
"prevent preferential treatment to insiders without imposing stricter
standards on insider credit than on credit to other borrowers."[^8]
However, as noted above, Regulation O clearly provides that a violation
occurs if *either* test is not met. Concluding otherwise would render
superfluous the section 215.4(a)(1)(ii) requirement that a loan present
no greater than normal repayment risk or present other unfavorable
features.

Moreover, preventing preferential treatment is not the only purpose of
Regulation O. Rather, its purpose has been more broadly described as
"prevent\[ing insiders\] of a bank from exerting undue influence over
the bank's lending activities"[^9] and "limiting borrowing by executive
officers and other insiders."[^10] If the sole purpose of Regulation O
were to prevent preferential treatment of insiders, there would be no
need for the regulation's imposition of quantitative limits or
prohibition on certain overdrafts. The OCC letters referenced above
predate the FRB's 1994 opinion, and we believe that the better view is
to read section 215.4(a)(1)(i) and (ii) as independent tests.

Accordingly, based on a plain reading of Regulation O as confirmed by
the Federal Reserve Board opinion referenced above, we conclude that a
national bank that renews a loan to an insider violates section
215.4(a)(1) of Regulation O and section 22(h)(2)(A) of the Federal
Reserve Act if the loan either (i) is preferential or (ii) involves more
than the normal risk of repayment or presents other unfavorable
features. To the extent that earlier OCC staff opinions have suggested
otherwise, [^11] they are hereby overruled. I trust this reply is
responsive to your inquiry. If you have any questions regarding the
foregoing, please contact Aline J. Henderson at (202) 874-5300.

Sincerely,

**-signed-**

Daniel P. Stipano

Acting Chief Counsel

[^1]: 12 U.S.C. § 375b(2)(A).

[^2]: 12 C.F.R. § 215.4(a)(1).

[^3]: 12 C.F.R. § 215.4(a)(1)(ii).

[^4]: 12 C.F.R. § 215.3(a).

[^5]: 12 C.F.R. § 215.4(a)(1)(i) and (ii); *see also* 12 U.S.C.
    § 375b(2)(A) (emphasis added).

[^6]: *See* Op. G.C. FRB (Oct. 21, 1994), 1994 Fed. Res. Interp. Ltr.
    LEXIS 322. Although the letter did not address Regulation O's
    preferentiality prohibition, by concluding that a loan may violate
    Regulation O if it violates § 215.4(a)(1)(ii), the letter implicitly
    supports the proposition that the loan need not also be preferential
    in order to give rise to a violation of Regulation O. *See also*
    Federal Reserve Bank of Dallas Staff Opinion (Ltr. from Millard E.
    Sweatt, Jr., Vice President and General Counsel, May 24, 1984) ("The
    general proscriptions of Regulation O, as set forth in Section
    215.4(a), not only require that extensions of credit to insiders be
    made on substantially the same terms as those prevailing for
    comparable transactions with non-insiders, but also prohibit any
    extension of credit to insiders that involves more than the normal
    risk of repayment or that presents other unfavorable features.")

[^7]: *See, e.g.*, OCC Interp. Ltr. No. 443 (June 28, 1988) ("The OCC's
    position is that once an insider loan has been identified as posing
    a credit weakness, it may be renewed only if a comparable loan to a
    non-insider would be renewed."). *See also* OCC Unpublished Interp.
    Ltr. (Oct. 31, 1990) (same conclusion). Another OCC letter opines in
    part that a bank can renew a loan to an insider that presents more
    than the normal risk of repayment if the purpose of the loan renewal
    is to improve the loan's credit quality. *See* OCC Unpublished
    Interp. Ltr. (Jun. 18, 1990). Although this letter did not cite to a
    specific provision of Regulation O for this proposition, the writer
    may have had in mind § 215.3(b)(4)(ii), which excludes from the
    definition of extension of credit "any indebtedness to a bank for
    the purpose of protecting the bank against loss or of giving
    financial assistance to it." But the FRB has opined that this
    provision "is intended to enable an insider to protect a bank
    against loss arising from a credit extended to an unrelated third
    party," and that it would not permit a bank "to renew a loan to an
    insider, assuming the renewal would \[otherwise\] violate Regulation
    O, where the insider is already obligated to repay the bank." Op
    G.C. FRB (Jun. 14, 1989).

[^8]: OCC Unpublished Interp. Ltr. (Oct. 31, 1990).

[^9]: Op. G.C. FRB (Apr. 5, 1989).

[^10]: Op. G.C. FRB (Feb. 28, 1995).

[^11]: *See, e.g.,* OCC Interp. Ltr. No. 443 (June 28, 1988); OCC
    Unpublished Interp. Ltr. (Oct. 31, 1990) and; OCC Unpublished
    Interp. Ltr. (Jun. 18, 1990).