Legal Lending Limits Applicable to Banks

A key consideration when a bank makes a loan or issues a commitment is whether the proposed loan of commitment, together with all outstanding loans to the same borrower, will case the bank to exceed its lending limits. Lending limits exist to control the concentration of credit and promote the diversification of bank assets. Exceeding the lending limits is serious and can expose directors to personal liability. Importantly, lending limits can apply when a legally binding written commitment is made, not at the time when funds are disbursed. Thus, it is necessary to determine before the commitment letter is issued whether the loan can be made without a participant or co-lender.

Section 5(u) of the Home Owners’ Loan Act (HOLA) provides that the national bank lending limit statute, 12 U.S.C. 84 applies to savings associations in the same manner and to the same extent as it applies to national banks. A national bank’s total outstanding loans and extensions of credit to a single borrower may not exceed 15% of the bank’s capital and surplus. A bank’s capital and surplus is generally the sum of its Tier 1 and Tier 2 capital plus the balance of its allowance for loan and lease losses not already included in Tier 2 capital. A national bank may lend an additional 10% of the bank’s capital and surplus, if the amount that exceeds the bank’s 15% general limit is fully secured by readily marketable collateral. To qualify for the additional 10% limit the bank must perfect a security interest in the collateral under applicable law and the collateral must have a current market value at all times of at least 100% of the portion of the loan or extension of credit that exceeds the bank’s 15% general limit.

Pursuant to 12 C.F.R. 32.2(q)(1)(i), the term “loans and extensions of credit” is defined to include “a contractual commitment to advance funds.” A “contractual commitment” to advance funds is defined to include a “qualifying commitment to lend.” A “qualifying commitment to lend” is defined, in part, as a “legally binding written commitment to lend that, when combined with all other outstanding loans and qualifying commitments to a borrower, was within the national bank’s or savings association’s lending limit when entered into and has not been disqualified. The OCC lending limit regulation authorizes a lead bank to deduct from the amount of its commitment the amount of “any legally binding loan participation commitments that are issued concurrent with the bank’s or savings association’s commitment” and that meet certain criteria.

.Banks frequently sell participations in loans in order to stay within their lending limits. The portion of a loan or extension of credit sold as a participation by a national bank or savings association on a non recourse basis does not constitute loans or extensions of credit for purposes of 12 U.S.C. 84, provided that the participation results in a pro rata sharing of credit risk proportionate to the respective interests of the originating and participating lenders. When a participation agreement provides that repayment must be applied first to the portions sold, a pro rata sharing will be deemed to exist only if the agreement also provides that, in the event of a default or comparable event defined in the agreement, participants must share in all subsequent repayments and collections in proportion to their percentage participation at the time of the occurrence of the event.

The OCC has imposed a “next day” funding requirement that must be met in order for the lead bank to deduct the loan from its lending limits calculations. When an originating national bank or savings association funds the entire loan, it must receive funding from the participants before the close of business of the next business day. If the participating portions are not received within that period, then the portions funded will be treated as a loan by the originating bank or savings association to the borrower. If the portions so attributed to the borrower exceed the originating bank’s or savings associations lending limit, the loan may be treated as nonconforming subject to Section 32.6, rather than a violation if certain conditions are met.

Loans to one borrower are attributed to another person and both are considered a borrower when the proceeds are used for the direct benefit of the other person, or when a common enterprise is deemed to exist between the persons. For this reason, in calculating the lending limits, it is necessary to aggregate loans made to separate borrowers when the loan, although ostensibly made to one person, is used to benefit another, or when borrowers are engaged in a common enterprise. In determining whether a loan to one borrower should be attributed to another borrower for lending limit purposes, one must apply each of the five loan combination/attribution tests discussed below - the one direct benefit test and the four common enterprise tests - to the specific facts of each loan relationship.

Direct Benefit Test. The proceeds of a loan to a borrower are deemed to be used of the direct benefit of another person and are attributed to that persons when the proceeds, or assets purchased with such proceeds, are transferred to that other person, other than in a bona fide arm’s length transaction where the proceeds are used to acquire property, goods, or services.

Common Source of Repayment Tests. The four common enterprise tests are set forth below.

Common Enterprise Test #1 - Common Expected Source of Payment. A common source of repayment is deemed to exist when the expected course of repayment for each loan is the same and neither borrower has another source of income form which the loan and the borrower’s other obligations can be repaid.

Common Enterprise Test #2 - Common Control and Significant Financial Interdependence. A common enterprise is deemed to exist when: (1) the borrowers are related though common control; and (2) there is substantial financial interdependence between and among the borrowers. Borrowers are related through common control when one person or entity controls another, or two of more entities are controlled by the same person on entity. Control is deemed to exist if a person directly on indirectly or acting through or together with one or more persons either (1) owns or controls 25% or more of the voting securities of another person, (2) controls in any manner the election of a majority of the directors or trustees of another person, or (3) has the power to exercise a controlling influence over the management or policies of another person. Substantial financial interdependence is deemed to exist when 50% or more of one person’s annual Forss receipts or gross expenditures (an an annual basis) are derived from transactions with the other person. Gross receipts and expenditures include gross revenue/expenses, intracompany loans, dividends, capital contributions, and similar receipts or payments.

Common Enterprise Test #3 - Borrowing to Acquire Control. A common enterprise also is deemed to exist when the borrowers use the loan proceeds to acquire more than 50% of a business enterprise.

Common Enterprise Test #4 - Facts and Circumstances. The OCC may determine that a common enterprise exists based upon the facts and circumstances of particular transactions. The OCC rulings and interpretations reveal that a very strong evidentiary record based upon a number of factors must exist before a common enterprise will be found to exist solely on the basis of the facts and circumstances tests. In interpretive letters, the OCC has considered the following facts and circumstances to be relevant to a common enterprise determination.

  • engaging in supporting lines of business

  • interchange of goods and services

  • common ownership of assets

  • common management

  • use of common facilities

  • commingling of assets and liabilities

  • closely related business activities

  • similarity in structure, financing and holding

  • use of same business address

  • centralized cash management program

  • likelihood that a financially troubled member of the group would receive financial aid from other members of the group

  • family relationships among the borrower

  • pledging of assets to support another person’s loans

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