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Legal Lending Limits and Credit Exposure for Derivatives – Georgia

As we previously discussed, the Georgia Department of Banking and Finance has confirmed that Georgia charted banks will be able to use any of the methodologies permissible for national banks when determining credit exposure for derivatives, subject to review through the examination process as to their appropriate implementation. For those elements of the OCC methodology requiring the written approval of the OCC prior to implementation, the Department’s written approval would likewise be required prior to implementation by Georgia state-chartered banks.

Notwithstanding this broad permission, we think that most community banks will find the “Conversion Factor Matrix Method” to be less burdensome and easier to calculate. Under the Conversion Factor Matrix Method, credit exposure is calculated as follows:

Credit Exposure equals Current Credit Exposure plus Potential Future Exposure [12 CFR § 32.9(b)(1)(i)]

The exposure will remain fixed at the potential future credit exposure of the derivative transaction as determined at the execution of the transaction. The conversion matrix is set out in the legal lending limit rule adopted by the OCC and set out in the updated CFR.

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Legal Lending Limits and Credit Exposure for Derivatives

On June 19, 2013, the OCC issued a final rule (the “Rule”) updating its existing regulations on legal lending limits in response to Section 610 of the Dodd Frank Act. Section 610 amended the federal lending limits statute, (12 USC § 84) to include credit exposures arising from derivative transactions and repurchase agreements, reverse repurchase agreements, securities lending transactions, and securities borrowing transactions. The Rule also takes into account differences that existed between national banks and saving associations and preserves some of the statutory exceptions that savings associations previously enjoyed. The Rule replaces, and modifies to some extent, the Interim Rule adopted on June 20, 2012. The Rule provides three different methods for calculating credit exposure, one of which will be applicable to larger banks and two that will be more attractive to regional and community banks.

The Rule is relevant to state chartered banks as well since Section 611 of Dodd Frank provides that state banks may only engage in derivative transactions if the law of the sate takes into account credit exposure to derivatives. Over the last two years state legislatures passed laws addressing this issue.  [See, e.g.: GA Code Ann § 7-1-285 amended to include credit exposure under a derivative when calculating a bank’s legal lending limit to any one borrower]. State banking departments have also promulgated rules advising state chartered banks on which model they should follow. [See, e.g., California:  “California state chartered banks shall use the Conversion Factor Matrix Method to determine the credit exposure of derivative transactions for purposes of complying with California’s lending limit;” Maryland: “For the purposes of calculating the Derivative-Securities Credit Exposure for compliance with the Maryland Limit, the Commissioner will require state-chartered banking institutions to measure the Derivative-Securities Credit Exposure in accordance with and subject to the limitations and exemptions under the OCC’s Interim Final Rule, as amended by the final rule upon issuance.”]

The Georgia  DBF has confirmed that Georgia charted banks will be able to use any of the methodologies permissible for national banks when determining credit exposure for derivatives, subject to review through the examination process as to their appropriate implementation. For those elements of the OCC methodology requiring the written approval of the OCC prior to implementation, the Department’s written approval would likewise be required prior to implementation by Georgia state-chartered banks. Notwithstanding this broad permission, we think that most community banks will find the “Conversion Factor Matrix Method” to be less burdensome and easier to calculate.

Under the Conversion Factor Matrix Method, credit exposure is calculated as follows:

Credit Exposure equals Current Credit Exposure plus Potential Future Exposure [12 CFR § 32.9(b)(1)(i)]

The exposure will remain fixed at the potential future credit exposure of the derivative transaction as determined at the execution of the transaction. The conversion matrix is set out in the legal lending limit rule adopted by the OCC and set out in the updated CFR.

The Rule lends itself very well to state regulatory application in that it is devised in a manner that will allow banks to adopt a compliance regimen that fits their size and risk management requirements, subject to an overall requirement that whichever method they choose is always subject to safety and soundness requirements.

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Legal Lending Limits and Credit Exposure for Derivatives

On June 20, 2012,  the OCC issued an interim final rule (the “Rule”) that amends its existing regulations on legal lending limit in response to Section 610 of the Dodd Frank Act. Section 610 amended the federal lending limits statute, (12 USC § 84) to include credit exposures arising from derivative transactions and repurchase agreements, reverse repurchase agreements, securities lending transactions, and securities borrowing transactions. The Rule also takes into account differences that existed between national banks and saving associations and preserves some of the statutory exceptions that savings associations previously enjoyed. The Rule provides three different methods for calculating credit exposure, one of which will be applicable to larger banks and two that will be more attractive to regional and community banks.

The Rule is relevant to state chartered banks as well since Section 611 of Dodd Frank provides that state banks may only engage in derivative transactions if the law of the sate takes into account credit exposure to derivatives. During the past legislative session many state legislatures passed laws addressing this issue.  For example, Georgia amended its legal lending limit statute, GA Code Ann § 7-1-285 to include credit exposure under a derivative when calculating its legal lending limit to any one borrower. The Georgia statute also allows a bank to determine the actual credit exposure pursuant to a methodology acceptable to the Department of Banking and Finance and the bank’s primary federal regulator. One would expect the various state regulators to look very carefully at the three options presented by the OCC when determining the method they will approve for their respective state. The Rule lends itself very well to state regulatory application in that it is devised in a manner that will allow banks to adopt a compliance regimen that fits their size and risk management requirements, subject to an overall requirement that whichever method they choose is always subject to safety and soundness requirements.

Specifically, the Rule provides that banks can choose to measure the credit exposure of derivatives (except credit derivatives) in one of three ways:

  1. through an OCC-approved internal model,
  2. by use of a look-up table that fixes the attributable exposure at the execution of the transaction, or
  3. by use of a look-up table that incorporates the current mark to market and a fixed add-on for each year of the transaction’s remaining life.

For credit derivatives (transactions in which banks buy or sell credit protection against loss on a third-party reference entity), the Rule provides a special process for calculating credit exposure, based on exposure to the counterparty and reference entity. With respect to securities financing transactions, institutions can choose to use either an OCC-approved internal model or fix the attributable exposure based on the type of transaction (repurchase agreement, reverse repurchase agreement, securities lending transaction, or securities borrowing transaction).

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Georgia DBF Revises Interpretation of Legal Lending Limit Statute

On Friday, November 5, 2010, the Georgia Department of Banking and Finance determined that the final rule being adopted to address loan renewals will not contain the requirement that the loan be a performing loan, and elected not to make any revisions to Rule 80-1-5-.01.  In addition to withdrawing the proposed rule, the Georgia DBF has affirmatively confirmed that it no longer interprets the statute as pertaining only to “performing” loans.  As we’ve previously discussed, this brings the Georgia legal lending limits in the context of a loan renewal into parity with the comparable requirements for national banks.

The Georgia DBF’s announcement was as follows:

In an effort to ensure parity between state and federally chartered banks regarding the renewal of loans, the Department no longer interprets 7-1-285(c)(9) as pertaining to only “performing” loans as originally stated in our February 2010 bulletin. Bankers are encouraged to familiarize themselves with 7-1-285(c)(9) and ensure that safe and sound underwriting procedures are undertaken and documented when making these renewal/restructuring decisions.

Credit Debit and Prepaid Cards,  cc
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Georgia DBF Withdraws Proposed Rule

On Friday, October 22, 2010, the DBF announced that it was withdrawing the proposed rule as it relates to the legal lending limit for further study. Both the Georgia Bankers Association and the Community Bankers Association sent the DBF comment letters opposing the change.

Arguments against adopting the proposal were based on two points, one based on legal interpretation and the second on practicalities. The first is that the proposed rule reads into the statute something that is simply not there. If the legislature had wanted to limit the loan renewals to ones that were performing it could have easily done so. The fact that they did not should be read as a decision by the legislature not to limit the renewal provision in that way.

The second point is based on the fact that a restrictive interpretation will put state chartered banks on a competitive disadvantage with national banks. Apparently the OCC does not read its regulations allowing for renewal of loans when the bank’s capital has shrunk to require that a loan be performing in order to be renewed or restructured.

We will keep readers apprised of further developments as they occur.

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Georgia DBF Proposes Rule to Address Legal Lending Limit Statute

The Georgia Department of Banking and Finance announced proposed rule making on September 23, 2010 to conform DBF rules to statutory changes adopted in the 2010 legislative session.  One of those rules addresses the issues that have arisen concerning interpretation of the amendment to the Georgia legal lending limit statute. That amendment was adopted earlier this year in response to many banks finding themselves unable to renew loans due to the fact that loan renewals were treated as a new extension of credit for legal lending limit purposes and banks had suffered capital reductions making the renewal unlawful. HB 926 was proposed as a means to allow state chartered banks in Georgia to deal with this situation in the same way that national banks currently deal with it. The legal lending limit for national banks is found at 12 USC § 84 and the applicable regulations are found in 12 CFR § 32.2.  The OCC regulations do not consider a loan renewal to be an extension of credit for purposes of the legal lending limit.   12 CFR § 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 § 32.3(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 lending limit.

The amendment to the Georgia statute used a similar approach.  A bank must use reasonable efforts to try and bring a loan into compliance with the legal lending limit. If it is unable to do so then the bank would be authorized to renew the loan even though its capital has shrunk and the loan would constitute a violation of the legal lending limit. The revised statute now provides that a renewal or restructuring of a loan following the exercise by the bank of reasonable efforts, consistent with safe and sound banking practices, to bring the loan into conformance with the lending limits of the statute will not be considered a new extension of credit unless unless:

(A) New funds are advanced by the bank to the borrower, except as permitted under the statute;

(B) A new borrower replaces the original borrower; or

(C) The department determines that a renewal or restructuring was undertaken as a means to evade the bank’s lending limit.

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Georgia DBF Issues Proposed Rules for Comment

On September 23, 2010, the Georgia Department of Banking and Finance (DBF) published proposed new and amended loan-to-one-borrower and mortgage industry rules to conform DBF rules to statutory changes adopted in the 2010 legislative session.  The DBF invites comments on the rules through October 25, 2010.

The primary rule change affecting community banks is a clarification of the DBF’s interpretation of the exception from the state’s legal lending limit for the renewal and restructuring of maturing loans.

In addition, new definitions would clarify the reach of the DBF’s loan-stacking rule and the limitation applicable to loans to “corporate groups.”  “Control,” “capital,” and “surplus” would track definitions in Regulation O, 12 C.F.R. § 215, and in the context of national banks.  Under the loan-stacking or “common enterprise” concept, loans to separate borrowers are aggregated for purposes of the lending limit in part when there is a relationship between the parties that includes control and financial interdependence.  Loans to corporate groups—corporations and their subsidiaries—are separately capped at 50% of capital and surplus, as defined.

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Georgia Amends Legal Lending Limit Statute

On February 11, 2010, the Governor signed House Bill 926 (HB 926), an amendment to the Georgia legal lending limit statute, to permit banks to renew maturing loans without violating the legal lending limit statute. The Georgia legal lending statute is found at Ga. Code Ann.§ 7-1 -285.  The statute is supplemented by the rules adopted by the Georgia Department of Banking and Finance, specifically Rule 80-1-5-.01(12).  The amendment was proposed as a solution to a problem which many banks are currently facing due to a reduction in their capital base. At issue is the language in the Rule which states that a bank may not renew a loan which although proper when made would now no longer meet the legal lending limit requirement.

“(12)  Where the “statutory capital base” as defined in Section 7-1-4(35) is reduced by operating losses, loan losses, or for other reasons, existing debt which was in conformity with the legal limitations at the time it originated shall not be construed to be non-conforming with new legal limitations resulting from the reduced statutory capital base; provided, however, in the absence of agreements to the contrary and originating at the time such debt originated regarding repayment programs for the debt in question, any extension, renewal, rollover or the like of the existing debt shall be determined to be a new loan and must conform to the new, lower lending limitations.” (emphasis added)

Due to a shrinkage in capital many banks are faced with loans which are maturing but that the regulations will not allow to be renewed.  As a practical matter these loans are not subject to being repaid immediately due to lack of liquidity by borrowers nor are there any other financial institutions willing to take over the credits. Banks are forced to enter into forbearance type arrangements which does not result in the loan being renewed and must carry the loan on their books as past due.

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