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4000 - Advisory Opinions
Transaction with Affiliated Equipment Leasing
Company--Applicability of § 23A, § 23B and 12 CFR § 250.250
FDIC--95--19
August 29, 1995
Lisa R. Chavarria, Attorney
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.
I. Background
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
{{2-29-96 p.4938}}arrangement between the Leasing Company
and the Affiliated Banks is substantially equivalent to similar
transactions between a leasing company and an unrelated party.
II. Applicable Statutes and Interpretative Rulings
A. Section 23A of Federal Reserve Act
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).
B. Section 23B of Federal Reserve Act
Section 23B, 12 U.S.C.
§ 371c--1, also places restrictions on a bank's ability to
engage in certain transactions with affiliates. Section 23B provides:
A member bank and its subsidiaries may engage in any of the
transactions described in paragraph (2) only--
(A) on terms and under circumstances, including
credit standards, that are substantially the same, or at least as
favorable to such bank or its subsidiary, as those prevailing at the
time for comparable transactions with or involving other nonaffiliated
companies, or
(B) in the absence of comparable transactions, on terms and under
circumstances, including credit standards, that in good faith would be
offered to, or would apply to, nonaffiliated companies.
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).
{{2-29-96 p.4939}}
C. 12 C.F.R. § 250.250
In 1974, the Board of Governors of the Federal Reserve System
("Board of Governors") issued an interpretative ruling, 12 C.F.R.
§ 250.250, excluding from the definition of "extension of credit''
the purchase of mortgage notes by a bank from a nonbank affiliate,
subject to several restrictions. In relevant part, the interpretation
provides the following:
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).
III. Analysis
A. "Covered Transactions" Under Sections 23A and 23B
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.
B. Application of 12 C.F.R. § 250.250
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
{{2-29-96 p.4940}}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.
{{2-29-00 p.4941}}
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.
Even if, under § 250.250, the proposed transactions were excluded
from the Section 23A definition of covered transaction, the FDIC notes
it would subject these transactions to safety and soundness review as
if the Nonmember Bank itself were the originator of the leasing
arrangements. That is, a nonmember bank's purchase of a lease from an
affiliated leasing company would be subject to FDIC safety and
soundness review, including but not limited to, examination of credit
risk, concentration risk, as well as risk-related return present in
these transactions. In addition, the FDIC would consider the particular
circumstances of a nonmember bank requesting authority to engage in
such transactions. Accordingly, the FDIC will limit, on a case-by-case
basis, the aggregate number of leases purchased by nonmember banks from
an affiliated leasing company, as well as the percent of capital
invested in such leases. 3
C. Section 23B
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.
IV. Conclusion
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.
{{2-29-00 p.4942}}
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.
1 Section 23A provides in relevant part that a member bank and
its subsidiaries may engage in a covered transaction with an affiliate
only if--
(A) in the case of any affiliate, the aggregate
amount of covered transactions of the member bank and its subsidiaries
will not exceed 10 per centum of the capital stock and surplus of the
member bank; and
(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.
12 U.S.C. § 371c(a)(1).
Section 18(j)(1) of the Federal Deposit Insurance Act,
12 U.S.C. § 1828(j)(1),
makes Sections 23A and 23B applicable to nonmember insured banks in the
same manner and to the same extent as if they were members of the
Federal Reserve System. Go Back to Text
2 This requirement protects against the risk that a bank may
purchase loans from an affiliate in order to alleviate the affiliate's
capital needs rather than on the merits of a proposed transaction. This
risk would be particularly manifest where a bank is the sole source of
the affiliate's funding. Go Back to Text
3 With respect to leases qualifying for exclusion from the
Section 23A definition of "covered transactions" under
§ 250.250, the Board of Governors itself has not had the opportunity
to opine officially whether there is a strict dollar amount of
transactions that would qualify under § 250.250. Staff, however,
believes that when a bank buys more than fifty percent of an
affiliate's leases, the transaction begins to appear to be a funding
mechanism for an affiliate and less of an investment opportunity for
the bank. Moreover, Board of Governors' staff has indicated that where
a bank's portfolio contains a significant volume of any single type of
asset, as in this case where a bank's purchase of leases from an
affiliate represents 100 percent of its capital, that concentration of
assets could raise significant safety and soundness concerns. Go Back to Text
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