CBAI LEGAL: Bank or Bank Holding Company Stock as Collateral
Jerry Cavanaugh CBAI General Counsel
Pursuant to Section 37 of the Illinois Banking Act (for state‐chartered banks) and Section 7.2019 of the regulations adopted by the Office of the Comptroller of the Currency (“OCC”) for national banks, banks in Illinois are prohibited from taking shares of their own bank stock as collateral when making a loan. However, the OCC Regulation allows a national bank to execute agreements with its stockholders that would require a stockholder to pledge shares if, subsequent to the loan being made, the national bank concludes that additional security has become necessary to prevent loss. Although Section 37 of the Illinois Banking Act does not have a comparable provision for acceptance of bank shares as an additional protection against loss, such authority exists in the so‐called “wild card” statute that grants a state‐ chartered bank parity with whatever a national bank in Illinois is authorized to do [ Section 5(11) of the Illinois Banking Act].
Both the state law and the OCC Regulation apply to the bank’s “own” shares of stock. Can a bank in Illinois accept a pledge of shares of its bank holding company (“BHC”) or of an affiliated bank (i.e., a bank commonly owned by the same BHC) at the time of the making of the loan? The answer is “Yes,” but state banks would be subject to Section 35.2 of the Illinois Banking Act and all banks in Illinois are subject to Federal Reserve Board (“Fed”) Regulation W (“Reg W”). Section 35.2 of the Illinois Banking Act essentially incorporates into state law the identical provisions of Reg W, and therefore for the remainder of this column I will address only Reg W.
Reg W is titled “Transactions Between Member Banks and Their Affiliates.” Although “Member Banks” in that title is a literal reference to banks that are Fed members, and many Illinois state‐chartered banks are not Fed members, the restrictions within Reg W have been adopted by the FDIC and thus extend to all state banks.
First, the definition of an “affiliate” to which Reg W restrictions apply includes both the bank’s BHC and any other bank(s) that is/are controlled by that same BHC.
The basic lending limit of a state bank for loans to one borrower is 25% of unimpaired capital and unimpaired surplus. However, for purposes of Reg W, the limit is 10% for “covered transactions” with any one affiliate and 20% for the aggregate of covered transactions with all affiliates. “Covered transactions” include not only direct loans to the affiliate but also loans to any persons when the collateral pledged consists of shares of stock issued by the affiliate(s).
Example #1: Jane Doe pledges shares of BHC stock to secure a loan in the amount of 8% of the bank’s capital and surplus. RESULT: The bank would only be able to make other loans to its BHC or make loans to other individuals who pledge BHC stock, in an amount up to 2% of capital and surplus, and total covered transactions with all other affiliated banks combined could not exceed 12%.
Example #2: A bank makes one or more direct loan(s) to its BHC totaling 8% of the bank’s capital and surplus and makes five loans, each equaling 3%, to five individuals who pledge shares in five different affiliated banks. RESULT: This is a Reg W violation because the 8% loan to the BHC and the five 3% loans to the individuals are all “covered transactions” and, in the aggregate, exceed 20% of capital and surplus.
Finally, Reg W requires that when a loan by a bank to an affiliate is secured by “stock, leases, or other real or personal property,” the collateral must have a market value equal to at least 130% of the loan amount at the time the loan is made.
Legal Link is a free CBAI member benefit. For answers to your general, banking‐related legal questions, contact CBAI General Counsel Jerry Cavanaugh at 800/736‐2224 (IL only), 217/529‐2265 or [email protected] or CBAI Paralegal Levette Shade at [email protected].