4000 - Advisory Opinions
FDIC Insurance of Accounts of Proposed Industrial Loan Company
January 4, 1988
Gerald J. Gervino, Senior Attorney
In your letter of December 11, 1987, you write on behalf of ***, a proposed industrial loan company, to be located in *** ("Applicant"), which had filed an application for Federal Deposit Insurance on November 24, 1987. You request an interpretation of the applicability or nonapplicability of Section 23A of the Federal Reserve Act, 12 U.S.C. 371c ("Section 23A"), to a proposed management agreement ("Management Agreement") between *** and its sole shareholder, ***.
*** is the sole proposed owner of Applicant. It is actively engaged in the business of originating loans under licenses issued by the *** Department of Corporations. As a limited partnership, *** hires none of its own employees or management personnel, but obtains all of its management and employee services through a personnel services agreement with its general partner, ***, a *** limited partnership, ***. Under this agreement, approximately 70 full time employees of *** devote 100% of their time to originating loans, processing loan documents, conducting credit and secured property evaluation procedures, servicing all loans and performing related administrative and accounting functions for ***. In return for these services, *** pays a fee to *** currently set at 33.7% of the loan origination fee paid by the borrower on each loan originated by the partnership (the "Base Fee") plus 3/8ths of 1% annually on the principal balance of each loan with an initial maturity of over three years. In addition, *** reimburses *** with employee salaries and related expenses of each employee who devotes 100% of his or her time to *** and does not own more than a 1% interest in ***.
You do not anticipate that Applicant will obtain a substantial number of loan referrals from ***. Applicant will not make any loans to *** for the purpose of paying off or otherwise refinancing an existing loan held by that borrower with ***.
Applicant will obtain management and certain loan origination services from *** under a Management Agreement which is substantially similar to the personnel services agreement between *** and ***. In addition, the applicant will maintain a basic staff of approximately 15 persons capable of running its depository functions. Through its arrangement with ***, Applicant will receive the benefit of services from experienced senior management, loan origination and loan servicing personnel. Under the Management Agreement, the senior managing officers of Applicant will not receive any direct compensation from the Applicant, but will only receive compensation from ***. In return for the above services, Applicant will pay *** a base fee equal to approximately one-third of the loan origination fee charged to borrowers on loans originated or acquired by Applicant, which is the same as the base fee paid by *** to *** and is similarly used by *** to compensate the senior managing officers, who receive no compensation from Applicant. With respect to personnel other than senior managing officers, Applicant will reimburse *** for a portion of its employee payroll expenses, the amount of which will be determined as a portion of *** payroll expenses equal to the size of Applicant's portfolio as a percentage of the combined loan portfolios of *** and the Applicant. *** will further provide its staff to service all loans made by Applicant, for which it will pay *** a loan servicing fee equal to 3/8ths of 1% annually on the principal balance of each loan held by *** with an initial term of three years or more.
Applicant determined to utilize the proposed Management Agreement for three reasons. Its provisions are substantially identical to those between *** and ***. Second, Applicant believes that the compensation provisions will benefit Applicant insofar as Applicant's cost will be matched to its actual revenues from loan originations. Third, in your opinion the terms of the agreement provide a fair allocation of expenses between *** and *** without complex time and recordkeeping requirements. Applicant's management believes the terms of the Management Agreement are a fair and administratively convenient means of compensating for management services provided by *** and ***.
You have concluded that the proposed Management Agreement does not constitute a "covered transaction" within the meaning of section 23A because the proceeds of loans made by Applicant are not used for the benefit or would be transferred to *** or any affiliate. Loan proceeds are disbursed directly to each borrower of loans made by Applicant for the borrower's own use, will not be used to pay off any amounts owed to ***. There is no direct disbursement of loan proceeds to *** under the management agreement. You feel the base fee is simply calculated as a percentage of loan fees as a convenient method of determining fairly the amount of compensation for management services actually rendered to *** by *** and ***.
From the information you have provided, it does not appear that Applicant is purchasing loans from its affiliate or lending money to its affiliate or otherwise engaging in covered transactions except to the extent if any, that referral of loans by affiliates to the Applicant might result in a benefit to the affiliates within the meaning of Section 23A(a)(2). Rather, the "benefit" which would be provided to the affiliates under this arrangement would vary with the facts of each referral (or pattern of referrals). Under the arrangement, as it appears, benefits of this source would occur in exceptional circumstances. Thus, in the ordinary workings of the Management Agreement, as we understand it, the proposed arrangement does not appear to present in itself a structure for the routine violation of Section 23A.
Section 23B of the Federal Reserve Act (Section 102(a) of Title I of the Act of August 10, 1987; Pub L. No. 100-86; 101 Stat. 564-566), ("Section 23B"), covers the payment of money or the furnishing of services to an affiliate under contract, lease, or otherwise. Section 23B(a)(2)(C), 12 U.S.C. § 371c-1(a)(2)(C). This new law limits transactions of the sort described above to those made only (a) on terms and under circumstances, including credit standards, that are substantially the same, or at least as favorable to the bank (Applicant) 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. Section 23B(a)(1)(A). We note that paragraph 4(f) of the Management Agreement states that nothing in the Management Agreement shall authorize *** or *** to collect, nor require Applicant to pay *** or *** for any services or overhead, if such services or overhead could be obtained from unaffiliated third parties at a lower cost to the applicant. This provision seems to fit the spirit of Section 23B and if actually followed in practice would appear to keep the arrangement within the bounds of Section 23B.
Our observation with respect to the proposed management relationship under the submitted Management Agreement are based on your representations and the general structure of the Management Agreement. Individual facts concerning a particular transaction that may or may not be consistent with the letter of the Management Agreement or a change in procedures, controlling relationships, or the Management Agreement could lead to a different conclusion on our part.