The attached Bulletin supercedes Bulletin B-04-4 (the legal lending bulletin) in an effort to address the problems that many banks are currently facing due to a reduction in their capital base. Under Bulletin B-04-4, a loan that was within the bank’s legal lending limit when made could become a legal lending limit violation due to fluctuations in its capital base upon an extension or renewal.
Due to declines in capital, some banks are faced with maturing loans which the Department’s legal lending limit bulletin (B-04-4) would not allow to be renewed or extended. As a practical matter many of these loans are not subject to being repaid immediately due to a lack of liquidity by borrowers nor may there be any other financial institutions willing to refinance or participate in the credits. Some banks have been forced to enter into forbearance type arrangements which do not result in the loan being renewed, thereby forcing the bank to reflect the loan on its books as past due.
The Department is amending its previous stance with regard to renewals and extensions so that state-chartered banks are treated in a similar fashion as national banks which can amend or extend loans without triggering a legal lending limit violation so long as certain criteria are met. The legal lending limit for national banks is found at 12 USC Section 84 and the applicable regulations are found in 12 CFR Section 32. The OCC regulations do not consider a “loan renewal” to be an “extension of credit” for purposes of the legal lending limit. 12 CFR Section 32.2(k)(2)(iv) provides that an extension of credit does not include:
A renewal or restructuring of a loan as a new “loan or extension of credit,” following the exercise by a bank of reasonable efforts, consistent with safe and sound banking practices, to bring the loan into conformance with the lending limit, unless new funds are advanced by the bank to the borrower (except as permitted by Section 32.2(b)(5)), or a new borrower replaces the original borrower, or unless the OCC determines that a renewal or restructuring was undertaken as a means to evade the bank’s legal lending limit.
If a bank wishes to renew or extend a loan after its capital base has declined then the Board of Directors of the bank must provide prior written notice to the Department that it intends to engage in the practice of renewing or extending those type credits. After providing prior notice to the Department the bank can renew or extend loans without creating a legal lending violation so long as no new funds are extended; no new borrower replaces the original borrower; the credit analysis and documentation on file at the bank at the time of the renewal or extension substantiate that the renewal or extension is consistent with safe and sound banking practices; and the bank’s board of directors approves each individual renewal or extension.
Bulletin B-10-1 is attached hereto and incorporates the above changes in the next to last paragraph of the Bulletin. All other information on pages 1 through 3 remains unchanged from the prior Bulletin.
The legal lending limit is a safety and soundness measure intended to prevent one person or a relatively small and economically related group of persons from borrowing an unduly large amount of a bank’s funds. It is also intended to safeguard a bank’s depositors by diversifying the risk of loan losses among a relatively large number of creditworthy borrowers engaged in various types of businesses.
As such, if in any instance it shall appear, as determined by the Commissioner, that the interests of a group composed of individuals, partners, unincorporated associations, corporations, limited liability corporations, limited liability partnerships, trusts or joint-ventures are so interrelated that, from a credit standpoint, applying standard and customary banking practices, they should be considered a single unit for the purposes of extensions of credit, the total indebtedness of these interrelated customers shall be combined and treated as the indebtedness of a single customer in applying the legal lending limit.
Therefore, a loan or extension of credit to one person shall be considered a loan or extension of credit to a second person if the credit worthiness of the one person does not justify the loan or extension of credit without reliance on the credit worthiness of the second person.
Factors which may be relevant in determining whether a loan or extension of credit to one person can be justified without reliance on the credit-worthiness of a second person include:
(a) Will the credit analysis and documentation on file at the bank at the time the loan or extension of credit was made substantiate that the one person has or will have the financial capacity to generate sufficient funds from his or her own assets and operations to repay the loan or extension of credit or is the source of repayment the second person?
(b) Were the proceeds of the loan or extension of credit to one person used for the primary benefit of the one person or was a substantial portion of the proceeds used for the benefit of the second person without a corresponding economic benefit to the one person?
(c) Loans or extensions of credit to a partnership, joint venture, or association are deemed to be loans or extensions of credit to each member of the partnership, joint venture, or association. This provision does not apply to limited partners or to members of a joint venture or association if the partners or members, by the terms of the partnership or membership agreement, are not held generally liable for the debts or actions of the partnership, joint venture, or association, and those provisions are valid under applicable law.
Further, it is the policy of the Department that loans signed in a secondary capacity are not normally included in a person’s legal lending limit, however, loans guaranteed or otherwise signed in a secondary capacity should be included in the lending limit of an individual when one or both of the following factors are present:
(a) The person signing in a secondary capacity, rather than the maker, has the use and benefit of the proceeds of the loan; and/ or
(b) The person signing in a secondary capacity makes payments directly or indirectly on the loan.
If these factors are present, the note guaranteed or otherwise covered should be included in the individual’s lending limit along with any notes upon which he is primarily liable.
For the purposes of this policy, secondary capacity means a person’s liability as a guarantor, surety, or endorser as opposed to his or her direct liability as a maker or co-maker.
The Department interprets the term “capital, surplus and undivided profits”(as used in T.C.A. Section 45-2-1102(a)(1)) for purposes of calculating a bank’s legal lending limit to be the same as the bank’s Tier One Capital as reported in the bank’s most recent Consolidated Report of Condition and Income. Therefore, unrealized gains and intangibles should not be included in the bank’s “capital, surplus and undivided profits” for the purpose of calculating the bank’s legal lending limit. The Department’s interpretation of T.C.A. §45-2-1102 continues to permit banks to calculate their legal lending limit on a quarterly basis using Report of Condition data. Accordingly, the calculation should be performed at the end of each calendar quarter to determine the legal lending limit for the next quarter. For purposes of this Bulletin, the effective date of each calculation will be the earlier of the following dates: a) The date on which the bank's Consolidated Report of Condition and Income (Call Report) is submitted; or b) The date on which the bank's Call Report is required to be submitted.
T.C.A. Section 45-2-1102(a)(2) provides that no loan limit shall be applicable to any state-chartered bank in any situation or circumstance in which no loan limit is imposed upon national banks. This exception applies only to loans which a national bank may make without any loan limitation. Therefore, if a less restrictive limitation is imposed upon a national bank, a state-chartered bank may not rely upon T.C.A. Section 45-2-1102(a)(2) to use a loan limit that is less restrictive than otherwise imposed by state law. However, in many circumstances a state-chartered bank might rely upon T.C.A. Section 45-2-601, commonly referred to as the wild-card statute, to use a less restrictive loan limit than that imposed by T.C.A. Section 45-2-1102. The wild-card permits a state-chartered bank to exercise any power or engage in any activity which it could exercise or engage in if it were a national bank located in Tennessee provided that the activity is consistent with the bank’s safe and sound operation. Pursuant to 12 C.F.R. Section 32.1(c) there is no loan limit for a national bank’s loan to its affiliates. Therefore, a state-chartered bank can loan money to its affiliates (as that term is defined in 12 U.S.C. Section 37c (b) (1)) without regard to the limitations found at T.C.A. Section 45-2-1102. Even though there is no legal lending limit for a national bank’s loans to its affiliates – these loans would still be subject to the requirements of the Federal Reserve Act’s Part 23A and 23B as well as the Federal Reserve Board’s Regulation W. See 12 U.S.C. 371c, 371c-1 and 12 C.F.R. Section 223.
Generally, a Tennessee chartered bank can only lend up to fifteen percent (15%) of its Tier One Capital to any one borrower under T.C.A. Section 45-2-1102. However, a Tennessee chartered bank can lend up to twenty-five percent (25%) of its Tier One Capital to any one borrower with the prior written approval of the board of directors or the finance committee. Under certain circumstances, state-chartered banks have requested permission to use the wild-card (T.C.A. Section 45-2-601) to calculate their legal lending limit based upon their Tier One Capital, Tier Two Capital and the ineligible portion of its Allowance for Loan and Lease Losses pursuant to the Office of the Comptroller of the Currency’s definition of capital contained in 12 C.F.R. Section 32.2(b). However, when using the wild-card, a bank is also subject to all of the other restrictions imposed upon a national bank. Pursuant to 12 C.F.R. Section 32.3(a) a national bank’s legal lending limit is fifteen percent (15%) of its capital with an additional ten percent (10%) available only if the additional ten percent (10%) is secured by readily marketable security as defined by 12 C.F.R. Section 32.2(n). Therefore, a state-chartered bank could only include Tier Two Capital and the ineligible portion of its Allowance for Loan and Lease Losses to determine its legal lending limit if it was willing to abide by the fifteen percent (15%) legal lending limit or twenty-five percent (25%) if the additional ten percent (10%) was secured by readily marketable security.
A loan or group of loans that are within the legal lending limit of a state bank at the time the loan or loans are made shall be valid for legal lending limit purposes until maturity, as stated in the original contract regardless of fluctuations in the bank’s legal lending limit. For purposes of this Bulletin only, a renewal or extension of a loan is not considered to be a “loan” as that term is used in T.C.A. Section 45-2-1102(a). The definition of a “loan” under other statutes may include a renewal or extension of a loan. For instance, an “extension of credit” for purposes of Regulation O governing loans to executive officers, directors and principal shareholders may include the renewal or extension of a loan. Therefore, if a bank’s legal lending limit is reduced due to fluctuations in its capital base, a loan or group of loans to a borrower or borrowers that were within the bank’s legal lending limit at the time they were made can be renewed or extended without creating a legal lending limit violation so long as: no new borrower replaces the original borrower; no additional funds are advanced; the credit analysis and documentation on file at the bank at the time of the renewal or extension substantiate that the renewal or extension is consistent with safe and sound banking practices; the renewal or extension of each such loan has received the prior approval of the bank’s Board of Directors, and; the bank, has provided prior written notice to the Department of Financial Institutions that it intends to enage in the practice of renewing or extending certain loans after a fluctuation in its capital base that has resulted in a reduction of its legal lending limit.
Questions regarding this bulletin may be directed to Assistant Commissioner – Bank Division Tod K. Trulove at (615) 741-6013 or General Counsel Tina G. Miller at (615) 532-1030.