Source: https://www.fdic.gov/regulations/laws/rules/4000-9490.html
Timestamp: 2019-04-19 04:48:52+00:00

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You have requested an opinion regarding whether the proposed purchase of equipment leases by state nonmember banks from a leasing company affiliated with such banks is subject to the restrictions on transactions with affiliates in Sections 23A and 23B of the Federal Reserve Act, 12 U.S.C. § § 371c and 371c-1. Based on the information you have provided, we have concluded that the transactions, as currently structured, are subject to the restrictions.
Investors of the "Bank" have established a commercial equipment leasing company, "Leasing Company", which will originate and sell commercial equipment leases to its affiliated banks and other financial institutions. The Leasing Company is an affiliate of nine depository institutions: seven state nonmember banks (the "Nonmember Banks"), one national bank, and one federal savings bank (together, the "Affiliated Banks"). Each of the Affiliated Banks is owned by a one-bank holding company. FDIC records show that the Leasing Company and each of the bank holding companies have a common group of shareholders that own at least twenty-five percent of the voting shares of each of these companies.
According to its business plan, the Leasing Company proposes to solicit, analyze, originate and service equipment leases which are designed to serve as a method of financing for a prospective lessee's acquisition of commercial equipment. The Leasing Company will locate prospective lessees and submit a general application credit package on each proposed lessee to an Affiliated Bank for its determination of the creditworthiness of the lessee, and for its commitment to purchase the lease. If the proposed lease and lessee are acceptable to the Affiliated Bank, the Leasing Company will purchase and lease the equipment and then sell and assign the lease to the financing Affiliated Bank as discussed below.
The Leasing Company will rely exclusively upon the Affiliated Banks as the sole purchaser of leases for the first eighteen months (twenty-four months at most), after which it will begin selling leases to other investors, as well as to the Affiliated Banks. The business plan assumes that each of the Affiliated Banks will invest up to 100 percent of its capital in leases originated by the Leasing Company.
According to the business plan, most transactions will be structured so that the Leasing Company transfers to the Affiliated Bank all its right, title, and interest in the lease, the equipment and all related documents. Alternatively, the Leasing Company will transfer and assign to the Affiliated Bank only its right, title and interest to monthly lease payments and provide the Affiliated Bank with a security interest in the underlying leased equipment. With certain narrow exceptions, the assignments by the Leasing Company to an Affiliated Bank will be without recourse to the Leasing Company.
The Leasing Company's income will be derived from fees stemming from the origination, transfer and servicing of the leases. The Leasing Company proposes to sell leases to the Affiliated Banks at a premium that will effectively lower the Affiliated Bank's yield on each lease by approximately 1.5 percent. The Leasing Company would collect an up-front servicing fee upon transfer of a lease to an Affiliated Bank that will further reduce the Affiliated Bank's yield by 2.0 percent. In addition, the Leasing Company will retain all origination fees as well as late charges associated with the collection of lease payments. The business plan states that "Accountant" supports Leasing Company's position that the fee arrangement between the Leasing Company and the Affiliated Banks is substantially equivalent to similar transactions between a leasing company and an unrelated party.
Section 23A of the Federal Reserve Act, 12 U.S.C. § 371c, imposes security and amount limitations on a federally insured bank's loans to, and investments in, its affiliates.1 One of the primary purposes of Section 23A is to safeguard the resources of a bank against misuse for the benefit of organizations under common control with the bank. The restrictions are designed to prevent a bank from risking too large an amount in affiliated ventures and to assure that extensions of credit to affiliates will be repaid. 12 C.F.R. § 250.250(b).
The transactions subject to the restrictions of Section 23A are broadly defined as "covered transactions" and include "a purchase of assets" from an affiliate. 12 U.S.C. § 371c(b) (7)(C). The statute defines "affiliate'' as any company "that is controlled directly or indirectly, by a trust or otherwise, by or for the benefit of shareholders who beneficially or otherwise control, directly or indirectly, by trust or otherwise, the member bank or any company that controls the member bank." 12 U.S.C. § 371c(b)(1)(C)(i). A shareholder is deemed to have control over another company if the shareholder "directly or indirectly, or acting through one or more other persons owns, controls, or has power to vote 25 per centum or more or any class of voting securities of the other company." 12 U.S.C. § 371c(b)(3)(A)(i).
12 U.S.C. § 371c--1(a)(1). Transactions described in paragraph (2) that are subject to these restrictions include: any covered transaction with an affiliate as defined in Section 23A, and "[t]he payment of money or the furnishing of services to an affiliate under contract, lease or otherwise". 12 U.S.C. § 371c-1(a)(2)(A), (a)(2)(C) and (d)(3).
There would be no loan or extension of credit [for purposes of Section 23A] by the member bank to its mortgage banking affiliate if the member bank's commitment to purchase the loan, or a participation therein, is obtained by the affiliate within the context of a proposed transaction or series of proposed transactions, in anticipation of the affiliate's commitment to make such loan(s), and is based upon the bank's independent evaluation of the creditworthiness of the mortgagor(s).
1974 Fed. Res. Bull. 726, reprinted in 1 Fed. Res. Reg. Serv. 3-1133 (Aug., 1974) and 12 C.F.R. § 250.250. See 1 Fed. Res. Reg. Serv. 3-1167.1 (Staff Opinion provides that a member bank will not be deemed to have purchased an asset from an affiliate, which would otherwise be included in the definition of covered transaction, if the criteria of § 250.250 are satisfied) (May, 1990).
The threshold issues are whether Leasing Company and the Nonmember Banks are "affiliates" and whether the leasing transactions described in the business plan are "covered transactions" as defined under Sections 23A and 23B. If they are, then the Nonmember Banks' transactions with Leasing Company will be subject to the limitations of Sections 23A and 23B, unless the transactions fall within the narrow exemption to covered transactions set forth in § 250.250.
Included within the definition of affiliate is any company "that is controlled directly or indirectly, by a trust or otherwise, by or for the benefit of shareholders who beneficially or otherwise control, directly or indirectly, by trust or otherwise, the member bank or any company that controls the member bank." 12 U.S.C. § 371c(b)(1)(C)(i). Under Section 23A, a shareholder is deemed to have control over another company if the shareholder "directly or indirectly, or acting through one or more other persons owns, controls, or has power to vote 25 percentum or more or any class of voting securities of the other company." 12 U.S.C. § 371c(b)(3)(A)(i). Each of the Affiliated Banks is owned by a one-bank holding company, and Leasing Company and each of the bank holding companies have a common group of shareholders that own at least twenty-five percent of the voting shares of each of these companies. Thus, each Affiliated Bank is an affiliate of Leasing Company as defined in Sections 23A and 23B. 12 U.S.C. §§ 371c(b)(1)(C)(i) and 371c-1(d)(1). See 1 Fed. Res. Reg. Serv. 3-1146.6 (Feb., 1990).
A covered transaction is broadly defined and includes "a purchase of assets" from an affiliate. 12 U.S.C. §§ 371c(b)(7)(B) and 371c-1(d)(3). Lease payments, leases and equipment are assets of the Leasing Company, the purchase of which by an Affiliated Bank would clearly fall within the definition of covered transaction. Thus, the leasing transactions described in the business plan are subject to the restrictions provided in Sections 23A and 23B.
The next issue is whether the two types of transactions described in the business plan fall within the exemption to covered transactions under § 250.250, and are thus exempt from the limitations of Section 23A. In the most common type of transaction anticipated under the business plan, the Leasing Company will transfer all its interest in a new equipment lease and in the underlying equipment to an Affiliated Bank. The second form of leasing transaction involves the Leasing Company's transfer and assignment to an Affiliated Bank of all its interest in monthly lease payments under a new equipment lease. In connection with such transfer, the Leasing Company will also provide the Affiliated Bank with a security interest in the leased equipment subject to the lease.
The Legal Division of the Board of Governors has issued an opinion providing that a member bank could purchase leases pursuant to § 250.250, if the leases were essentially financing arrangements and if the transactions satisfied the other requirements of § 250.250. FRB Op. Dep. G.C. (Nov. 22, 1985). The two types of transactions described in the business plan are similar to the purchase of a mortgage note discussed in § 250.250. In both transactions, a bank makes an investment by purchasing a stream of income and obtains a security interest in the underlying property. In § 250.250, the stream of income is evidenced by a mortgage note, a debt instrument, while in the Affiliated Banks' transactions, the stream of income is evidenced in the lease agreement.
Although an equipment lease agreement is not technically a debt instrument, it has many of the same economic characteristics as a mortgage note. Both the lease agreement and the mortgage note involve the investment by a bank with an expectation that the ensuing payments will result in a return on the initial investment, and in both transactions the bank retains a security or ownership interest in the property subject to the lease or mortgage. Thus, the assignment of a lease agreement (or lease payments) is within the very limited scope of transactions that the Board of Governors has exempted from Section 23A restrictions, provided that the transactions satisfy the other requirements in § 250.250.
Where a Nonmember Bank acquires an interest in a lease from Leasing Company, the transaction must also satisfy the following requirements under § 250.250: first, Leasing Company cannot lease or commit to lease before the Nonmember Bank has obligated itself to purchase the lease. 1 Fed. Res. Reg. Serv. 3--1133 (Aug., 1974); and 1 Fed. Res. Reg. Serv. 3--1189 (June, 1979). Second, the Nonmember Bank must independently evaluate the creditworthiness of a prospective lessee prior to any advance commitment on the part of the Nonmember Bank to fund the lease. Id. The business plan states that an Affiliated Bank will not make a commitment to purchase a lease until it has made an independent evaluation of the lessee's creditworthiness. It appears that the business plan satisfies these requirements.
Third, the exemption under § 250.250 is not available if a bank's purchase of an asset is to finance the working capital needs or activities of an affiliate. 1 Fed. Res. Reg. Serv. 3--1167.1 (May, 1990).2 According to the business plan, the Leasing Company will rely on the Affiliated Banks as the only purchasers of its equipment leases for eighteen months, and perhaps as long as two years. The business plan reflects no intention on the part of the Leasing Company to market its leases to nonaffiliated banks during this period. The Leasing Company's income will be derived from fees it will charge for its origination and servicing of the leases. As the only purchasers of the leases, the Affiliated Banks would be the only source of Leasing Company's income for at least eighteen months. We believe that such an arrangement is beyond the parameters established by the Board of Governors at § 250.250 and in subsequent staff opinions stating that transactions between a bank and its affiliate should not be used as a funding mechanism for the affiliate.
Moreover, the premium and up-front servicing fee arrangement between Leasing Company and the Affiliated Banks also appears to serve the purpose of providing Leasing Company with funding. Typically, a servicer collects servicing fees in the form of a monthly fee, usually a percentage of payments collected. In contrast to such transactions, the business plan requires that an Affiliated Bank pay an up-front servicing fee to Leasing Company for the life of the lease. The premium and servicing fees are additional to the origination and late charges that Leasing Company will retain. It appears that this fee arrangement may be designed to finance Leasing Company's activities or its working capital needs during the up to two year period of time when Leasing Company will be relying almost exclusively on the Affiliated Banks' purchases of its leases.
Thus, even though the transactions described above are the type of transaction that would be covered by § 250.250, Leasing Company's fee arrangement in conjunction with its exclusive reliance on the Affiliated Banks as the sole purchasers of its leases for up to two years makes § 250.250 inapplicable. Accordingly, the proposed transactions, as currently structured, are subject to the limitations under Section 23A.
Section 23B places restrictions on a bank's ability to engage in certain transactions with affiliates including the "payment of money . . . to an affiliate under contract, lease, or otherwise" by requiring that such an arrangement be comparable to terms involving nonaffiliated companies. 12 U.S.C. § 371c--1(a)(2)(C) and (a)(1)(A). In the lease transactions at issue, the Leasing Company will receive payment for servicing the leases transferred to an Affiliated Bank. These servicing fees do not appear to be comparable to terms involving nonaffiliated companies because, as discussed above, a servicer generally collects servicing fees on an on-going basis as a percentage of payments collected. The business plan, however, requires an Affiliated Bank to pay all servicing fees for the life of the lease at the time the lease is purchased. It does not appear, therefore, that this fee arrangement between Nonmember Banks and Leasing Company would be a transaction on terms and under circumstances for comparable transactions involving nonaffiliated companies as required by Section 23B.
Based on the foregoing, the FDIC concludes that the transactions described in Leasing Company's business plan are not within the scope of transactions exempted from the restrictions of Section 23A under § 250.250. In addition, the FDIC has determined that Leasing Company's proposed servicing fee arrangement appears to be a violation of Section 23B. If Leasing Company were to revise its business plan to conform with the requirements discussed in this legal opinion, the FDIC would review such plan with respect to the applicability of Sections 23A and 23B.
We note that the legal staffs of the Federal Reserve System, the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS) concur in the legal conclusions expressed herein. This notwithstanding, we advise you to contact the OCC and OTS, the respective primary federal regulators for Bank's national bank and federal savings bank, in order to afford these agencies the opportunity to review and opine on the terms of the transactions you have described.
Finally, we apologize for the delay in our responding to your letter. If you have further questions, please contact John J. Oldenburg, Jr., Senior Regional Attorney, at the Kansas City Regional Office at (816) 234-8049 or me at (202) 898-6891.
(B) in the case of all affiliates, the aggregate amount of the covered transactions of the member bank and its subsidiaries will not exceed 20 per centum of the capital stock and surplus of the member bank.

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