Financial Institutions, Administration

Rule R331-23

Lending Limits for Banks, Industrial Loan Corporations

Notice of Proposed Rule

(Amendment)

DAR File No.: 37020
Filed: 10/31/2012 02:17:08 PM

RULE ANALYSIS

Purpose of the rule or reason for the change:

In July 2010, the President of the United States signed the Dodd--Frank Wall Street Reform and Consumer Protection Act (DFA). A stated objective of the DFA was to promote the stability of the financial system. Section 611 of the DFA states that a state bank may engage in derivative transactions only if the law of the state takes into consideration "credit exposure to derivative transactions". With the passage of S.B. 108, during the 2012 General Session of the Utah Legislature, the department may by rule define the terms "credit exposure to a derivative transaction" and "derivative". The proposed amendment provides the necessary changes to the rule to enable state banks to continue to engage in derivative transactions.

Summary of the rule or change:

The change includes in total loans and extensions of credit, credit exposure to derivative transaction for purposes of limitations on loans and extensions of credit for banks and industrial banks. It provides new definitions for "credit exposure to a derivative transaction" and "derivative". Finally, the change provides that risk mitigation and valuation of risk to credit exposure to derivative transactions must be appropriately considered by banks and industrial banks engaging in derivative transactions.

State statutory or constitutional authorization for this rule:

• Section 7-1-301
• Section 7-3-19
• Section 7-8-20

Anticipated cost or savings to:

the state budget:

No impact on the state budget as compliance to the rule affects the depository institutions themselves not the department.

local governments:

Local governments are not involved in regulating depository institutions and are therefore not subject to this rule.

small businesses:

Depository institutions, under the jurisdiction of the Department, are currently permitted to engage in derivative transactions, however, if the proposed amendments are not made, they will be unable to engage in such transactions after 01/21/2013. In addition, the amendments to the rule should have minimal budgetary impact.

persons other than small businesses, businesses, or local governmental entities:

Depository institutions, under the jurisdiction of the Department, are currently permitted to engage in derivative transactions, however, if the proposed amendments are not made, they be will unable to engage in such transactions after 01/21/2013. In addition, the amendments to the rule should have minimal budgetary impact.

Compliance costs for affected persons:

Depository institutions, under the jurisdiction of the Department, are currently permitted to engage in derivative transactions, however, if the proposed amendments are not made, they be will unable to engage in such transactions after 01/21/2013. In addition, the amendments to the rule should have minimal budgetary impact.

Comments by the department head on the fiscal impact the rule may have on businesses:

Depository institutions, under the jurisdiction of the Department, are currently permitted to engage in derivative transactions, however, if the proposed amendments are not made, they will unable to engage in such transactions after 01/21/2013. In addition, the amendments to the rule should have minimal budgetary impact.

Edward Leary, Commissioner

The full text of this rule may be inspected, during regular business hours, at the Division of Administrative Rules, or at:

Financial Institutions
AdministrationRoom 201
324 S STATE ST
SALT LAKE CITY, UT 84111-2393

Direct questions regarding this rule to:

• Paul Allred at the above address, by phone at 801-538-8854, by FAX at 801-538-8894, or by Internet E-mail at [email protected]

Interested persons may present their views on this rule by submitting written comments to the address above no later than 5:00 p.m. on:

12/17/2012

This rule may become effective on:

12/24/2012

Authorized by:

Edward Leary, Commissioner

R331. Financial Institutions, Administration.

R331-23. Lending Limits for Banks, Industrial Loan Corporations.

R331-23-1. Authority, Scope, and Purpose.

(1) The Department of Financial Institutions enacts this rule under authority granted by Sections 7-1-301, 7-3-19, and 7-8-20.

(2) The rule applies to all loans and extensions of credit, including credit exposure to a derivative transaction, made by banks and industrial loan corporations chartered in the state and their subsidiaries.

(3) The rule is intended to prevent one person from borrowing an unduly large amount of a given bank's or industrial loan corporation's funds, thereby exposing the bank's or industrial loan corporation's depositors, creditors and stockholders to excessive risk.

(4) The rule provides exceptions to the general lending limits set forth in Sections 7-3-19 and 7-8-20.

(5) The rule does not apply to loans, extensions of credit and the credit exposure to a derivative transaction made by a bank or an industrial loan corporation to a subsidiary. The rule does not apply to [an]loans, extensions of credit and the credit exposure to a derivative transaction that [is]are subject to, or expressly exempted from, a federal statute or regulation limiting the amount of total loans and credit that may be extended to any person or group of persons.

 

R331-23-2. Definitions.

(1) "Affiliate" means any institution that controls the bank or industrial loan corporation and any other institution that is controlled by the institution that controls the bank or industrial loan corporation. However, "affiliate" does not include a subsidiary of the bank or industrial loan corporation.

(2) "Commissioner" means the Commissioner of Financial Institutions.

(3) "Contractual commitment to advance funds" means:

(a) an obligation on the part of the bank or industrial loan corporation to make payments to a third party contingent upon default by the bank's or industrial loan corporation's customer in the performance of an obligation under the terms of that customer's contract with the third party or upon some other stated condition, or

(b) an obligation to guarantee or stand as surety for the benefit of a third party. The term includes standby letters of credit, guarantees, puts and other similar arrangements. A binding, written commitment to lend is a "contractual commitment to advance funds" if it and all other outstanding loans to the borrower are within the bank's or industrial loan corporation's lending limit on the date of the commitment.

(4) "Consumer" means the user of any products, commodities, goods, or services, whether leased or purchased, and does not include any person who purchases products or commodities for the purpose of resale or for fabrication into goods for sale.

(5) "Consumer paper" includes paper relating to automobiles, mobile homes, recreational vehicles, residences, office equipment, household items, tuition fees, insurance premium fees, and similar consumer items.

(6) For purposes of the rule, "Control" means the ownership or control of at least 50% of the voting stock.

(7) "Current market value" means the bid or closing price listed for financial instruments in a regularly published listing or an electronic reporting service.

(8) "Credit Exposure to a Derivative Transaction" means the risk to earnings or capital of an obligor's failure to meet the terms of any derivative with the institution or otherwise to perform as agreed. It arises any time institution funds are extended, committed, invested, or otherwise exposed through actual or implied contractual agreements, whether reflected on or off the balance sheet.

(9) "Derivative" means a contract, agreement, swap, warrant, note, or option that is based, in whole or in part, on the value of, any interest in, or any quantitative measure or the occurrence of any event relating to, one or more commodities, securities, currencies, interest or other rates, indices, or other assets.

([8]10) "Financial instruments" means stocks, notes, bonds, and debentures traded in a national securities exchange, OTC margin stocks, as defined by the Federal Reserve Board at 12 CFR 220.2, 1996, commercial paper, negotiable certificates of deposit, bankers acceptances, and shares in money market and mutual funds of the type which issue shares in which banks or industrial loan corporations may perfect a security interest.

([9]11) "Institution" means "institution" as defined in Section 7-1-103.

(1[0]2) "Investment grade securities" means marketable obligations in the form of a bond, note or debenture rated in one of the four highest ratings of a nationally recognized rating agency. "Investment grade securities" does not include investments which are predominantly speculative in nature.

(1[1]3) "Loans and extensions of credit" means any direct or indirect advance of funds in any manner whatsoever to a person. This is made on the basis of any obligation of that person to repay the funds, or repayable from specific property pledged by or on behalf of a person. "Loans and extensions of credit" includes:

(a) A purchase under repurchase agreement of securities, other assets or obligations other than investment grade securities in which the purchasing bank or industrial loan corporation has a perfected security interest, with regard to the seller but not as an obligation of the underlying obligor of the security;

(b) An advance by means of an overdraft, cash item, or otherwise;

(c) A contractual commitment to advance funds;

(d) An acquisition by discount, purchase, exchange, or otherwise of any note, draft, or other evidence of indebtedness upon which a person may be liable as maker, drawer, endorser, guarantor, or surety;

(e) A participation without recourse, with regard to the participating bank or industrial loan corporation, but not the originating bank or industrial loan corporation;

(f) Existing loans, leases, or advances which have been charged off on the books of the bank or industrial loan corporation in whole or in part and which are legally enforceable, including statutory bad debt under Section 7-3-25 or Section 7-8-15 respectively.

(1[2]4) "Loans and extensions of credit" does not include:

(a) A receipt by a bank or industrial loan corporation of a check deposited in or delivered to the bank or industrial loan corporation in the usual course of business unless it results in the carrying of a cash item for the granting of an overdraft other than an inadvertent overdraft in a limited amount that is promptly repaid;

(b) An acquisition of a note, draft, bill of exchange, or other evidence of indebtedness through a merger or consolidation of financial institutions or a similar transaction by which an institution acquires assets and assumes liabilities of another institution, or foreclosure on collateral or similar proceeding for the protection of the bank or industrial loan corporation, provided that the indebtedness is not held for a period of more than three years from the date of the acquisition, unless permission to extend the period is granted by the commissioner on the basis that holding the indebtedness beyond three years is not detrimental to the safety and soundness of the acquiring bank or industrial loan corporation ;

(c) An endorsement or guarantee for the protection of a bank or industrial loan corporation of any loan or other asset previously acquired by the bank or industrial loan corporation in good faith or any indebtedness to a bank or industrial loan corporation for the purpose of protecting the bank or industrial loan corporation against loss or of giving financial assistance to it;

(d) Non-interest bearing deposits to the credit of the bank or industrial loan corporation;

(e) The giving of immediate credit to a bank or industrial loan corporation upon uncollected items received in the ordinary course of business;

(f) The purchase of investment grade securities subject to repurchase agreement in which the purchasing bank or industrial loan corporation has a perfected security interest, or where the securities are purchased from the state or any political subdivision thereof;

(g) The sale of Federal funds;

(h) Loans or extensions of credit which have become unenforceable by reason of discharge in bankruptcy or are no longer legally enforceable for other reasons.

(1[3]5) "Person" means "person" as defined in Section 7-1-103.

(1[4]6) "Readily marketable collateral" means financial instruments which are salable under ordinary circumstances with reasonable promptness at a fair market value determined by quotations based on actual transactions on an auction or similarly available daily bid and ask price market.

(1[5]7) "Sale of Federal Funds" means any transaction among depository institutions involving the transfer of immediately available funds resulting from credits to deposit balances at Federal Reserve banks or from credits to new or existing deposit balances due from a correspondent depository institution.

(1[6]8) "Standby letter of credit" means any letter of credit, or similar arrangement however named or described which represents an obligation to the beneficiary on the part of the issuer:

(a) To repay money borrowed by or advanced to or for the account of the account party, or

(b) To make payment on account of any indebtedness undertaken by the account party, or

(c) To make payment on account of any default by the account party in the performance of an obligation.

(1[7]9) "Subsidiary" means "subsidiary" as defined in Section 7-1-103.

([18]20) "Total capital" means the sum of capital stock, surplus, undivided profits, reserve for contingencies, reserves for loan losses, and the portion of subordinated notes and debentures with more than one year maturity remaining.

 

R331-23-3. General Rule.

(1) The total loans[ and], extensions of credit and the credit exposure to a derivative transaction by a bank or industrial loan corporation to any person outstanding at one time and not fully secured, as determined in a manner consistent with this rule, by collateral having a market value at least equal to the amount of the loan or extension of credit may not exceed 15% of the amount of the bank's or industrial loan corporation's total capital.

(2) The total loans[ and], extensions of credit and the credit exposure to a derivative transaction by a bank or industrial loan corporation to a person outstanding at one time and fully secured by readily marketable collateral having a market value, as determined by reliable and continuously available price quotations, at least equal to the amount of the funds and standing may not exceed 10% of the total capital of the bank or industrial loan corporation. This limitation is separate from and in addition to the 15% limitation described in Subsection (1), above.

(a) At all times, the total loans or extensions of credit to a person based on the limitation for banks in Section 7-3-19(2) and for industrial loan corporations in Rule R331-23-3(2) shall be secured by readily marketable collateral having a current market value of at least 100% of the total amount of funds outstanding, excluding accrued or discounted interest.

(b) Each bank or industrial loan corporation shall institute adequate procedures to ensure that the collateral value fully secures the outstanding loan or extension of credit at all times. At a minimum, each bank or industrial loan corporation shall perfect its security interest in the collateral and shall calculate the market value of the collateral at least monthly, or more frequently, as may be deemed necessary to ensure compliance with Section 7-3-19(2) for banks and Rule R331-23-3(2) for industrial loan corporations.

(c) If collateral values fall below 100% of the outstanding loan, the bank or industrial loan corporation must, within 60 days, obtain additional collateral in an amount sufficient to provide 100% coverage, require reduction of the loan or extension of credit, or sell the collateral and liquidate the debt. During this period, the loan or extension of credit will be considered nonconforming.

 

R331-23-4. Combining Loans to Separate Borrowers - General Rule.

(1) Loans[ or], extensions of credit and derivative transactions to one person will be combined where the proceeds of the loan[ or], extension of credit and derivative transactions are to be used for the direct benefit of any other person or persons.

(2) Loans[ or], extensions of credit and derivative transactions to a general partnership, joint venture or association shall, for purposes of this rule, be considered loans or extensions of credit jointly and severally to each member of such partnership, joint venture or association unless the agreement creating the general partnership, joint venture or association provides otherwise, in which case the loans or extensions of credit shall be allocated to each member only to the extent provided for by the terms of any such agreement.

(3) The sum of all loans[ or], extensions of credit and the credit exposure to a derivative transaction by a bank or industrial loan corporation outstanding at any one time to a person and all of its affiliates may not exceed 50% of the bank's or industrial loan corporation's total capital.

 

R331-23-5. Exceptions to the Lending Limits.

(1) The lending limits do not apply to the portion of a loan or extension of credit that represents accrued or discounted interest.

(2) Loans Secured by U.S. Obligations and General Obligations of a state or political subdivision.

(a) Loans[ or], extensions of credit and the portion of any credit exposure to a derivative transaction secured by bonds, notes, certificates of indebtedness or Treasury bills of the United States or by other similar obligations fully guaranteed as to the principal and interest by the United States or general obligations of a state or a political subdivision are not subject to any limitation based on total capital.

(b) This exception applies only to the extent that loans[ or], extensions of credit and the portion of any credit exposure to derivative transactions are fully secured by the current market value of obligations of the United States or guaranteed by the United States or general obligations of a state or political subdivision.

(c) If the market value of the collateral declines to the extent that the loan or the credit exposure to a derivative transaction is no longer in conformance with this exception and exceeds the general 15% limitation, the loan or the credit exposure to a derivative transaction must be brought into conformance within 60 days.

(3) Loans to or Guaranteed by a Federal Agency

(a) Loans or extensions of credit to or secured by unconditional takeout commitments or guarantees of any department, agency, bureau, board, commission, or establishment of the United States or any corporation wholly owned directly or indirectly by the United States shall not be subject to any limitation based on total capital.

(b) This exception may apply to only that portion of a loan or extension of credit that is covered by a federal guarantee or commitment.

(c) For purposes of this exception, the commitment or guarantee must be payable in cash or its equivalent within 60 days after demand for payment is made.

(d) A guarantee or commitment is unconditional if the protection afforded the bank or industrial loan corporation is not substantially diminished or impaired in the case of loss resulting from factors beyond the bank's or industrial loan corporation's control. Protection against loss is not materially diminished or impaired by procedural requirements, such as an agreement to take over only in the event of default, including default over a specific period of time, a requirement that notification of default be given within a specific period after its occurrence, or a requirement of good faith on the part of the bank or industrial loan corporation.

(4) Loans Secured by Segregated Deposit Accounts

(a) Loans[ or], extensions of credit and the portion of any credit exposure to a derivative transaction secured by a segregated deposit account in the lending bank or industrial loan corporation shall not be subject to any limitation based on total capital.

(b) The bank or industrial loan corporation must ensure that a security interest has been perfected in the deposit, including the assignment of a specifically identified deposit and any other actions required by state law.

(c) Deposit accounts which may qualify for this exception include deposits in any form generally recognized as deposits. In the case of a deposit eligible for withdrawal prior to the maturity of the secured loan or[,] derivative transaction, the bank or industrial loan corporation must establish internal procedures which will prevent the release of the security.

(5) Loans to Financial Institutions with the Approval of the commissioner

(a) Loans or extensions of credit to any financial institution or to any receiver, conservator, or other agent in charge of the business and property of such financial institution, when such loans or extensions of credit are approved by the commissioner, shall not be subject to any limitation based on total capital.

(b) This exception is intended to apply only in emergency situations where a bank or industrial loan corporation is called upon to provide assistance to another financial institution.

(6) Discount of Consumer Paper

(a) This exception allows a bank or industrial loan corporation to discount negotiable or nonnegotiable installment consumer paper of one person in an amount equal to 10% of its total capital (in addition to the 15% permitted by Section 7-3-19(1) and Section 7-8-20(1)) if the paper carries a full recourse endorsement or unconditional guarantee by the person transferring such paper. The unconditional guarantee may be in the form of a repurchase agreement or a separate guarantee agreement. A condition reasonably within the power of the bank or industrial loan corporation to perform, such as the repossession of collateral, will not be considered to make conditional an otherwise unconditional agreement.

(b) Under certain circumstances, consumer paper which otherwise meets the requirements of this exception will be considered a loan or extension of credit to the maker of the paper rather than the seller of the paper. Specifically, where (i) through the bank's or industrial loan corporation's files it has been determined that the financial condition of each maker is reasonably adequate to repay the loan or extension of credit, and (ii) any officer designated by the bank's or industrial loan corporation's Chairman or Chief Executive Officer pursuant to authorization by the Board of Directors certifies in writing that the bank or industrial loan corporation is relying primarily upon the maker to repay the loan or extension of credit, the loan or extension of credit is subject only to the lending limits of the maker of the paper. Where paper is purchased in substantial quantities, the records, evaluation, and certification may be in such form as is appropriate for the class and quantity of paper involved.

(7) Loans Secured by Livestock

(a) This exception allows a bank or industrial loan corporation to make loans or extensions of credit to one person in an amount equal to 10% of its total capital, in addition to the 15% permitted by Section 7-3-19(1) and Section 7-8-20(1), if the loans or extensions of credit are secured by livestock having a market value at least equal to 115% of the outstanding loan balance at all times. The loans or extensions of credit may be secured by shipping documents or other instruments which transfer title to, secure title to, or give a first lien on livestock. "Livestock" includes dairy and beef cattle, hogs, sheep, goats, horses, mules, poultry, and fish, whether or not held for resale. To support compliance with this exception, the bank or industrial loan corporation must maintain in its files an inspection and appraisal report on the livestock pledged.

(b) Under the laws of certain states, a person furnishing pasturage under a grazing contract may have a lien on the livestock for the amount due for pasturage. If the lien which is based on pasturage furnished by the lienor prior to the making of the loan (i) is assigned to the bank or industrial loan corporation by a recordable instrument and (ii) is protected against being defeated by some other lien or claim, by payment to a person other than the bank or industrial loan corporation, or otherwise, it would qualify under this exception provided the amount of such perfected lien is at least equal to the amount of the loan and the value of the livestock is at no time less than 115% of the loan. Where the amount due under the grazing contract is dependent upon future performance thereunder, the resulting lien has merely prospective value and does not meet the requirements of the exception.

(8) Loans to Student Loan Marketing Association, Utah Board of Regents or Utah Higher Education Assistance Authority

Loans or extensions of credit to the Student Loan Marketing Association, the Utah Board of Regents or the Utah Higher Education Assistance Authority are not subject to any limitation based on total capital.

(9) Loans to Industrial Development Authorities and Housing Authorities

A loan or extension of credit to an industrial development authority, housing authority or similar public entity in the state is not a loan or extension of credit to the authority provided that:

(a) The bank or industrial loan corporation relies on the credit of the lessee or owner of the facility to be financed by the loan or extension of credit;

(b) The authority's liability with respect to the loan is limited solely to whatever interest it has in the particular facility;

(c) The authority's interest is assigned to the bank or industrial loan corporation as security for the loan or a promissory note from the lessee or owner to the bank or industrial loan corporation provides a higher order of security than the assignment of a lease, trust deed or mortgage; and

(d) lessee's or tenant's rent or mortgage payment is assigned and paid directly to the bank or industrial loan corporation.

A loan or extension of credit meeting the above criteria will be deemed a loan or extension of credit to the lessee or owner and will be combined with other obligations of the lessee or owner for purposes of Section 7-3-19 and Section 7-8-20.

(10) Other Exemptions

With the written approval of the commissioner other exemptions to the provisions of Section 7-3-19 and Section 7-8-20 may be permitted.

 

R331-23-6. Credit Exposure to Derivative Transactions.

(1) Each bank or industrial loan corporation board of directors shall institute adequate policies and procedures to ensure that derivative positions are established for purposes of mitigating one or more risks inherent in an institution's normal business activities, and not for the purpose of increasing such exposure or for the purposes of speculation in price movement. The policies and procedures shall require the proper identification and prudent limitation of the risks associated with derivatives.

(2) Derivative transactions should be transacted subject to established market terms that provide for prudent counterparty risk mitigation techniques reflected in agreements developed by the International Swap Dealers Association ("ISDA").

(3) Valuation. Each bank or industrial loan corporation shall calculate the exposure to derivative transactions using a consistent method from one of the following:

(a) Internal Model Method.

(i) Credit exposure. The credit exposure of a derivative transaction under the Internal Model Method shall equal the sum of the current credit exposure of the derivative transaction and the potential future credit exposure of the derivative transaction.

(ii) Calculation of current credit exposure. A bank or industrial loan corporation shall determine its current credit exposure by the mark-to-market value of the derivative contract. If the mark-to-market value is positive, then the current credit exposure equals that mark-to-market value. If the mark-to-market value is zero or negative, then the current credit exposure is zero.

(iii) Calculation of potential future credit exposure. A bank or industrial loan corporation shall calculate its potential future credit exposure by using an internal model that has been, at least annually, validated by a qualified party independent from the valuation process.

(iv) Net credit exposure. A bank or industrial loan corporation that calculates its credit exposure by using the Internal Model Method pursuant to this paragraph may net credit exposures of derivative transactions arising under the same qualifying master netting agreement.

(b) Conversion Factor Matrix Method. The current credit exposure arising from a derivative transaction shall be equal to the product of the notional amount and conversion factor. The conversion factor is determined by asset class and by the maturity of assets: Interest rate, foreign exchange and gold derivatives are valued by multiplying the notional amount by the following multiples based on maturity of the contract: .015 for a maturity of 1 year or less, .03 for a maturity of 1-3 years, .06 for a maturity of 3-5 years, .12 for a maturity of 5-10 years, and .3 for a maturity of over 10 years. Equity derivatives, regardless of maturity will be multiplied by a factor of .2. Other derivatives, including commodities other than gold will be multiplied by: .06 for a maturity of a year or less, .18 for a maturity of 1-3 years, .3 for a maturity of 3-5 years, .6 for a maturity of 5-10 years and 1 for a maturity of over 10 years.

(c) Remaining Maturity Method. The current credit exposure arising from a derivative transaction under the Remaining Maturity Method shall be the greater of zero or the sum of the current mark-to-market value of the derivative transaction added to the product of the notional amount, the remaining maturity in years of the transaction and a fixed multiplicative factor. Like the conversion factor, the fixed multiplicative factor is determined by asset class, but instead of having a fixed value for purposes of the lending limit over the life of a contract, as the maturity diminishes so does the value for purposes of the lending limit. The fixed multiplicative factor for interest rate, foreign exchange and gold derivatives is 1.5%. For equity derivatives and any other derivatives including commodities the fixed multiplicative factor will be 6%.

 

R331-23-[6]7. Record Keeping.

(1) The board of directors shall review at least annually the most recent financial statements on all loans and extensions of credit, including credit exposure to a derivative transaction, to one person exceeding 10% of total capital. Based upon this review, the board of directors shall approve a determination that the conditions outlined in Rule R331-23-4 do not exist for such loans and extensions of credit. A statement of the above approval shall be incorporated into the minutes of the board of directors meeting at which the review was accomplished.

(2) In the case of loans and extensions of credit subject to the limitations of Section 7-3-19(2) and Rule R331-23-3(2), a record of the market value of the collateral securing such loans or extensions of credit shall be maintained as set forth in Rule R331-23-3.

 

KEY: loans, banks, industrial loan corporations

Date of Enactment or Last Substantive Amendment: [July 16, 1997]2012

Notice of Continuation: September 28, 2012

Authorizing, and Implemented or Interpreted Law: 7-3-19; 7-8-20