Bruce Moland, Esq.
Vice President and Assistant
    General Counsel
Wells Fargo and Company
Norwest Center
Sixth and Marquette
Minneapolis, MN 55479-1026

Dear Mr. Moland:

This is in response to your letter requesting that the Board review a 1984 staff interpretation concerning the calculation of the quantitative limits of section 23A of the Federal Reserve Act when a loan is made to an unrelated third party and is secured by securities issued by an affiliate as well as other types of collateral.¹

Section 23A of the Federal Reserve Act, originally enacted as part of the Glass-Steagall Act, was intended to prevent the misuse of a bank's resources through "non-arm's-length" transactions with its affiliates. Section 23A of the Federal Reserve Act limits certain covered transactions between a member bank and its subsidiaries and an affiliate to 10 percent of the institution's capital stock and surplus, and limits the aggregate amount of all transactions between a member bank (and its subsidiaries) and all of its affiliates to 20 percent.²

Section 23A(b)(7)(D) of section 23A defines as a covered transaction a bank's acceptance of securities issued by the affiliate as collateral security for a loan or extension or credit to any person or company.³ In its 1984 opinion, staff opined that, for purposes of the quantitative limit in section 23A, the value of an extension of credit that is secured in any part by securities of an affiliate is the amount of the entire loan rather than the value of securities pledged as collateral. This treatment helps to protect a bank against the possibility that an unaffiliated party might be used as a conduit to channel funds from the member bank to its affiliate.⁴

You have requested that staff revisit this opinion, and, in particular, consider whether it is appropriate to require inclusion of the entire loan amount under the section 23A limits if only a small percentage of the loan's collateral is represented by affiliate shares and the bank is not relying on the affiliate's shares to support the entire value of the loan. You argue that in certain cases, such as large loan syndications or other transactions where pools of various types of collateral are used for a customer's convenience and where the loan proceeds are not used to purchase the shares issued by an affiliate, a bank should be able to take an affiliate's securities as collateral without the loan amount counting toward bank's quantitative limit because the bank is not relying on the value of the affiliate's shares to support the entire loan.

Staff believes that in situations in which a loan is secured by affiliate shares and other collateral, it is reasonable to reflect the fair market value of the nonaffiliate collateral in determining the applicability of the quantitative limits in section 23A to loans by a bank to an unaffiliated third party. Staff believes that, for purposes of applying the quantitative limits in section 23A, such mixed-collateral loans should be valued at the lesser of (1) the total value of the loan less the amount of nonaffiliate collateral (if any) marked to fair market value, or (2) the fair market value of the affiliate's shares that are used as collateral. Under this method of calculation, if the loan is fully secured by collateral with a fair market value that equals or exceeds the loan amount (excluding the affiliate's shares), then the loan would not be included in the bank's quantitative limits for purposes of section 23A. If the loan is not fully secured by collateral excluding the affiliate's shares, then the amount that the bank must count against its quantitative limit is the difference between the full amount of the loan and the fair market value of the nonaffiliate collateral up to a maximum of the value of the affiliate's shares. This methodology takes account of the bank's reliance on the fair market value of nonaffiliate collateral in a loan transaction, while also recognizing that a portion of the loan may be supported by shares issued by an affiliate. If a substantial amount of a loan is secured with nonaffiliate collateral that was marked to its fair market value, then that part of the loan should not be subject to the quantitative limits of section 23A.

It should be noted that under section 23A, the securities issued by an affiliate are not acceptable collateral for a loan or extension of credit to any affiliate.⁵ Moreover, if the proceeds of the loan that are secured by the affiliate's shares are transferred to an affiliate by the third party borrower to purchase assets or securities from the affiliate, the loan is treated as a loan to the affiliate. The loan must then be secured with collateral in an amount and of a type that meets the requirements of section 23A for loans by a bank to an affiliate.⁶ Moreover, a loan that is secured with any amount of an affiliate's shares must be consistent with safe and sound banking practices.

If you have further questions, please contact Ms. Pamela G. Nardolilli of my staff at 202-452-3289.

Sincerely,

(Signed) J. Virgil Mattingly

J. Virgil Mattingly

1. F.R.R.S. 3-1199 (letter dated March 19, 1984). Return to text

2. 12 U.S.C. � 371c. By its terms, section 23A only applies to member banks. The Federal Deposit Insurance Act extended the coverage of section 23A to all FDIC-insured nonmember banks. 12 U.S.C. � 1828(j). The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 applies section 23A to FDIC-insured savings associations. 12 U.S.C. � 1468. Return to text

3. 12 U.S.C. � 371c(b)(7)(D). Return to text

4. F.R.R.S. 3-1199 (letter dated March 19, 1984). The letter also recognized that a bank could reduce the impact of this opinion by making two separate loans, one loan that would be secured by collateral that would be subject to section 23A, and one loan that is not. Return to text

5. 12 U.S.C. � 371c(c)(4). Return to text

6. F.R.R.S. 3-1167.3. Return to text