[Name redacted]

Dear [name redacted]:

This is in response to your letter dated November 12, 1998, concerning the application of the Board's Regulation O to a transaction involving a director of your bank and the director's adult son.

Based on your letter, it appears that the director made a loan to his son to finance the son's construction of a house. Several months later, the son refinanced the original loan by obtaining a loan from the bank at non-preferential terms and using the proceeds to pay off the original loan from the director. You have indicated that the amount of the original loan and the amount of the refinancing loan reflected the actual and reasonable cost to construct the house. There is no indication that the director will serve as the source of repayment of the bank's loan to the son. You have asked whether the bank's loan to the son should be attributed to the director under the Board's tangible economic benefit rule at 12 C.F.R. 215.3(f)(1), or whether the bank's loan qualifies for the exception from the tangible economic benefit rule at 12 C.F.R. 215.3(f)(2).

Under the tangible economic benefit rule, an extension of credit is considered made to an insider to the extent that the proceeds are transferred to the insider. 12 C.F.R. 215.3(f)(1). In this case, all the proceeds of the loan from the bank to the son were transferred to the director. The bank's loan to the son, therefore, is subject to the tangible economic benefit rule.

Under the exception to the tangible economic benefit rule, an extension of credit is not considered made to an insider if the terms of the extension of credit satisfy the criteria for an insider loan under 12 C.F.R. 215.4(a) and the proceeds of the extension of credit are used in a bona fide transaction to acquire property, goods, or services. 12 C.F.R. 215.3(f)(2). In this case, the bank's loan to the son satisfied all the criteria for an insider loan under 12 C.F.R. 215.4(a), but the son used the proceeds to pay off the original loan rather than to purchase the promissory note representing the original loan.

It is our opinion that the exception to the tangible economic benefit rule should apply in this case regardless of the manner in which the son retired the original loan from the director. The exception requires that an extension of credit be used in a bona fide transaction to acquire property, goods, or services in order to prevent transactions from qualifying for the exception when the borrower from the bank serves merely as a nominee for the insider. This would occur if the borrower from the bank transferred the proceeds of the bank loan to the insider without adequate consideration. In this case, in the absence of any evidence that the amount of the original loan from the director (which the loan from the bank was used to repay) was inflated beyond the actual and reasonable construction costs for the son's house, the Board's concern that the exception to the tangible economic benefit rule not be used to shield nominee loans would be satisfied.

It also should be noted that the transaction described above is identical in terms of the economic relationships it established among the parties and the credit risk assumed thereunder by the bank to an alternative transaction in which the director would have sold the son's note to the bank without recourse. The sale, or discount, of a promissory note to a bank, without recourse to the transferor of the note, is treated under Regulation O as the purchase of an asset by the bank and not as an extension of credit to the transferor. 12 C.F.R. 215.3(b)(7). Thus, if the director had sold the son's note to the bank without recourse, instead of the son obtaining his own loan from the bank to replace the note, then the transaction would not have been characterized as an extension of credit in the first place. The regulatory treatment of the transaction should not vary so greatly based solely on the form of the transaction.

This opinion applies only to the transaction described above, and does not address any other issues that may arise from the transaction. You also should contact the primary federal regulatory agency for the bank for confirmation of the opinion expressed herein. If you have any additional questions concerning this matter, you may contact Gordon Miller of my staff at 202/452-2534.

Sincerely,

(Signed) J. Virgil Mattingly

J. Virgil Mattingly