Dear Ms. Grandstrand:

This is in response to the request by Klein Financial, Inc. ("KFI"), Chaska, on behalf of its subsidiary bank, Preferred Bank, Big Lake, both of Minnesota, for an exemption from section 23A of the Federal Reserve Act¹ and the Board's Regulation W that would permit Preferred Bank to acquire certain assets and assume certain liabilities from KFI, including the outstanding capital stock of a KFI subsidiary, Home Town Mortgage ("HTM"). Preferred Bank is a wholly owned subsidiary of KFI and, accordingly, KFI and HTM are affiliates for purposes of section 23A.² KFI proposes to transfer the assets and liabilities to Preferred Bank as part of a corporate reorganization.

Section 23A limits the amount of "covered transactions," which include loans and purchases of assets, between a bank (and its subsidiaries) and any single affiliate to 10 percent of the bank's capital stock and surplus. Covered transactions include a bank's loans to an affiliate, investments in the securities of an affiliate, purchases of assets from an affiliate, and certain other transactions. In addition, a bank's purchase of assets from its affiliate is subject to a prohibition against the purchase of low-quality assets and must be on terms and conditions that are consistent with safe and sound banking practices.³ The transfer by KFI to Preferred Bank is a covered transaction under section 23A because a transfer of assets is treated as a purchase of assets by a bank from an affiliate to the extent that the bank assumes liabilities of its affiliate.⁴

Section 23A specifically authorizes the Board to exempt purchases of real or personal property and to exempt "at its discretion [other]. . . transactions or relationships from the requirements of this section if it finds such exemptions to be in the public interest and consistent with the purposes of this section."⁵ The Board has approved exemptions in similar cases for one-time transfers that are part of a corporate reorganization and that are structured to ensure the quality of the transferred assets.⁶ As in previous cases reviewed by the Board, the proposed transaction in this case is the result of a one-time corporate reorganization. KFI states that the proposed consolidation would allow it to simplify management and governance of the KFI organization, assist KFI in reducing or containing operating expenses, and enhance the efficiency of KFI's lending programs.

A majority of Preferred Bank's directors have reviewed and approved the proposed restructuring. In addition, Preferred Bank and KFI have made the following commitments, accepted by the Board in previous exemption requests:

1. None of the assets of KFI or its subsidiaries that will be purchased by Preferred Bank will be "low-quality" within the meaning of Regulation W.
2. KFI commits, for a two-year period following the completion date of the reorganization, to make quarterly cash contributions of Preferred Bank equal to the book value plus any write-downs taken by Preferred Bank, of any transferred assets that have become low-quality assets during the quarter.
3. KFI commits that, for a two-year period following the completion date of the reorganization, it will purchase or otherwise make Preferred Bank whole for any loans that are put back to Preferred Bank as a result of HTM's sales of loans into the secondary market where such sales occurred prior to the reorganization.

In light of these considerations and all the facts presented, the transaction appears to be consistent with safe and sound banking practices and on terms that would ensure the quality of the assets transferred. In addition, the Federal Deposit Insurance Corporation has informed the Board that it has no objection to this proposal. Accordingly, the transaction appears to be consistent with the purposes of section 23A, and the Director of the Division of Banking Supervision and Regulation, pursuant to authority delegated by the Board, and with the concurrence of the General Counsel, hereby grants the requested exemption.

This determination is specifically conditioned on compliance by KFI and Preferred Bank with all the commitments and representations made in connection with the request. These commitments and representations are deemed to be conditions imposed in writing in connection with this action and, as such, may be enforced in proceedings under applicable law. This determination is based on the specific circumstances surrounding this transaction and may be revoked in the event of any material change in those circumstances or any failure by KFI or its subsidiaries to observe their commitments. Granting this exemption does not represent a determination on the permissibility of any other transactions that are subject to section 23A or concerning any other affiliate of Preferred Bank.

Very truly yours,

(Signed) Robert deV. Frierson

Robert deV. Frierson
Deputy Secretary of the Board

1. 12 U.S.C. � 371c(b)(1)(A).0.  Return to text

2. Although section 23A and Regulation W apply by their terms only to member banks, section 18(j) of the Federal Deposit Insurance Act (12 U.S.C. � 1828(j)) provides that insured nonmember banks are subject to section 23A "in the same manner and to the same extent" as member banks. Accordingly, Preferred Bank, as an insured state nonmember bank, is subject to section 23A and Regulation W as if it were a member bank. Return to text

3. 12 U.S.C. � 371c(a)(3) and (4).  Return to text

4. 12 C.F.R. � 223.22(a)(1).  Return to text

5. 12 U.S.C. �� 371c(b)(7)(C) and 371c(e)(2) (emphasis added).  Return to text

6. See Travelers Group Inc., 84 Federal Reserve Bulletin 985, 1013-14 (1998); letter dated November 14, 1996, from William W. Wiles to John Byam; letter dated April 19, 1988, from James McAfee to Timothy C. Roach; letter dated August 6, 1987, from William W. Wiles to Timothy McGinnis.  Return to text