Background
A bank appealed the OCC's decision to deny its
proposed community development (CD) investment. The bank proposed to use a
parcel of other real estate owned (OREO) and to make a no
interest/no fee construction loan to its wholly-owned operating
subsidiary. The
operating subsidiary would complete the construction of a municipal
office building on the parcel.
The parcel was acquired as a result of the bankruptcy of the
developer who had already developed a shopping center and parking
garage on an adjacent lot.
The bank acquired the entire project as OREO and separated it
into two parcels. The
second parcel included the municipal office building. A government entity agreed
to purchase the office building upon its completion guarantee and a
payment and performance bond in favor of the operating
subsidiary. The project would provide the
bank with a cash recovery of $4.5 million, which would partially
offset a $7.7 million write-off the bank took on the original
loan.
The OCC ruled that the proposal, as structured
through its operating subsidiary, did not meet the requirements of
12 USC 24 (eleventh) and 12 CFR 24, and could be completed under
part 34. The regulatory
accounting for additions to OREO would normally be treated as
additions to a bank's nonperforming assets instead of as "other
assets." The bank's
appeal states that the structure of the project was in large part
dictated by the municipal government and its need to act within city
guidelines and regulations.
Bank management is puzzled that the OCC's denial letter
suggests that such a project must be carried out through a Community
Development Corporation (CDC).
They read part 24 as providing national banks the option of
undertaking CD investments either through a CDC or directly through
the bank. Further, bank
management believes that it is within the OCC's discretion to
determine that the additional investment need not be classified as
OREO. Although the accounting for the
initial investment would retain its OREO status, the appeal
requested that the additional investment be recorded as "other
assets."
Bank management views its proposal as exactly the
type of public purpose project envisioned by part 24. It benefits a depressed area
that includes census tracts with some of the lowest median incomes
in the
United
States. It creates jobs in this
community, which has the highest unemployment rate in the city. It benefits minority and
small businesses, and provides needed services by ensuring that the
project will remain as an anchor in the community. It represents the largest
commitment of CD financing and resources in the area. And it will serve as a
catalyst for encouraging other business and residential
development. If the safe and sound improvement
of OREO can be used as a catalyst for economic development in a
severely depressed area, bank management believes banks should be
permitted to rely on the CD authority and accounting, rather than
that of OREO, especially if the project does not involve speculative
development of real estate.
Discussion
Section 24 (eleventh) of the National Bank Act
authorizes national banks to "make investments, subject to specified
limits, designed primarily to promote the public welfare, including
the welfare of low-and moderate-income communities or families (such
as providing housing, services or jobs)". The statue authorizes banks
to make the investments directly or by purchasing interests in an
entity primarily engaged in making such investments. A bank may not make an
investment that would expose it to unlimited liability. Part 24 of Title 12 of the
Code of Federal Regulations implements section 24 (eleventh) and
provides guidance as to what is a permissible public welfare
investment.
Specifically, the OCC has stated
that it will consider a CDC or CD - project investment to be
primarily designed to promote the public welfare if all of the
following three criteria are met.
(1) The investment must
primarily benefit low- and moderate- income (LMI) persons and
families (such as by providing housing, services, or jobs) or small
businesses, including minority owned businesses.
The project primarily benefits LMI persons,
families, and small businesses. It will help stabilize a
low-income community in the city. It will provide customers
for small businesses and jobs for LMI persons. It will enhance the economic
vitality of the community.
The project will attract new businesses to the adjacent
shopping mall because of the patronage of the employees of the
municipal office tower.
Patronage from the employees will help stabilize the shopping
center and parking garage and preserve the viability of the
businesses already located there. The bank submitted studies and
economic plans for the community that envisions the project as the
centerpiece for future development in the community.
However, current OCC policy
requires that a bank's investment primarily benefit LMI persons,
families, and small businesses by providing them with new and
long-term benefits (such as housing, services, or jobs).
The bank's proposal was not clear how the
investment in the municipal office tower would primarily benefit LMI
persons or small businesses by providing long-term employment and
business opportunities.
During the appeal process, the bank clarified that even
though its investment was in the municipal office building, the bank
wanted consideration for the entire project, including the shopping
center and garage. The bank also provided additional
information that the entire project would provide long-term
employment opportunities for low-and moderate-income persons and
business opportunities for small businesses.
(2) The investment must
address community development needs not met by the private market in
one or more communities served by the bank, including, for example,
the needs of low-and moderate-income areas, underserved rural
communities, or government-designated redevelopment areas within a
town, city, county or state.
The bank indicates that the proposed investment
will be in an LMI area that has been underserved by the private
market. The proposal
indicates that the community has been an economically distressed
area for many years.
Much of the recent development in the community has been
undertaken with government subsidy and substantial involvement of
the nonprofit sector.
Further, the project was initially undertaken by a
profit-motivated entity that proved unsuccessful. The OCC concludes that the bank's
additional investment in the municipal office tower, as part of the
entire project, reflects its efforts to dispose of the OREO
property.
(3) There must be non-bank
community involvement in the CDC and CD project, indicating that the
affected primary beneficiaries and representative of local or state
government have endorsed and demonstrated support for the CDC or CD
project activities.
Because the bank is developing OREO through a
non-CD entity, the bank demonstrates an acceptable approach for
ensuring non-bank community involvement through its operating
subsidiary. Community
support for the project includes partnerships with a local economic
development organization and the president of the community
government and the involvement of the city as the purchaser of the
project. Because
the project involves an operating subsidiary, the OCC considered
alternative community involvement criteria.
As a policy matter, the OCC currently permits
banks to undertake real estate development, directly, under the OREO
regulation (part 34) and under the CD Investments regulation (part
24). In this case, because 90 percent
of the project was being managed by the bank's operating subsidiary,
it was more feasible for the OCC to permit the bank to complete the
construction of the project through its operating subsidiary and to
establish alternative community involvement criteria rather than
requiring the bank to move the OREO property to its existing
CDC.
Regarding the accounting for the transaction,
classification as OREO is not a relevant issue under generally
accepted accounting principles (GAAP). GAAP allows OREO to be
included as part of "other assets" but requires a separate footnote
disclosure if it is material.
This disclosure would quantify the balance of foreclosed
asset investments (inclusive of the additional project
investment). The
disclosure would include further narrative discussion of the nature
of this particular investment, setting forth a discussion of the
purpose of the additional investment and the existence of the
contract to purchase from the city.
For regulatory reporting, schedule RC-M of the
call report instructions states that all real estate other than bank
premises be classified as OREO. Further, the instructions to
schedule RC-F exclude from "other assets" real estate that is
acquired in any manner for debts previously contracted. However, the call report
instructions did not consider improvements to OREO such as those
associated with the project.
Accordingly, if the project qualifies as a permissible CD
project, the bank may account for it as a CD "other asset." Specifically, the bank would
classify it as an "asset held for short-term disposition."
Conclusion
The Ombudsman's Office decided to grant the
bank's appeal. The
ombudsman concluded that the bank's amended proposal to complete the
project is a permitted public welfare investment consistent with the
statute, regulation, and OCC policies. The bank may develop the
project directly through its operating subsidiary rather than
through a CD entity, such as its established CDC. Finally, the bank may carry
its additional investment in the project under "other assets"
instead of treating it as nonperforming assets. Consistent with GAAP a material
amount of OREO should be disclosed as such on schedule RC-F of the
call report.