I. INTRODUCTION
Lending limits laws are established for both state and national banks in order to prevent an undue concentration of credit by a bank to any one customer. Under these provisions, the total loans to any one person may not exceed the lending limit of the bank.
A. General Limitation for State-Chartered Banks
The lending limit for state banks is governed by Neb.Rev.Stat. § 8-141 which limits loans by a bank, directly or indirectly, to any single corporation, limited liability company, firm or individual, to no more than 25% of the paid-up capital, surplus and capital notes and debentures of the bank or 15% of the unimpaired capital and unimpaired surplus, whichever is greater. The limitations are subject to several exceptions (See, “IV. Exceptions to Lending Limits”). The term “unimpaired capital and unimpaired surplus” means: (1) a bank’s tier 1 and tier 2 capital included in the bank’s risk-based capital under the capital guidelines of the appropriate federal banking agency, based generally on the banks most recently filed call report; plus (2) the balance of the bank’s allowance for loan and lease losses not included in the bank’s tier 2 capital for purposes of the calculation of risk-based capital by the appropriate federal banking agency, based generally on the bank’s most recently filed call report.
B. General Limitation for National Banks
The lending limit for national banks is governed by OCC regulation found at 12 CFR Part 32. A national bank may not make a “loan or extension of credit” that is not fully secured by readily marketable collateral in excess of 15% of its “unimpaired capital and surplus” to any “person” (“person” includes partnerships, trusts, corporations and most other types of enterprises), however a national bank may extend additional credit in an amount equal to 10% of the bank’s unimpaired capital and unimpaired surplus, if the additional loan is secured by readily marketable collateral having at all times a current market value of at least 100% of the amount of the loan. If the collateral’s value falls below 100% of the outstanding loan, the loan becomes subject to the general 15% limitation and must be brought into conformance within 5 business days. For national banks, “unimpaired capital and unimpaired surplus” means: (1) a bank’s tier 1 and tier 2 capital calculated under the OCC’s risk-based capital standards; plus (2) the balance of the bank’s allowance for loan and lease losses not included in the bank’s tier 2 capital, for purposes of the calculation of risk-based capital (See, 12 CFR § 32.4 for further details).
II. DEFINITIONS OF LOANS OR EXTENSIONS OF CREDIT
A. State-Chartered Banks
For state banks, a loan is generally defined as the furnishing or delivery of anything of value under the condition that the thing of value loaned will be repaid. There are two requirements: (1) the actual advancement of something of value to the borrower; and (2) the promise to repay that advancement. In determining the amount of the loan for purposes of the loan limit statutes, any funds which have been advanced by the bank should be included in the amount of the loan (e.g., the amount of the loan proceeds and premiums for insurance which the bank pays for a customer including credit life, property or title insurance). NOTE: The discounting of bills of exchange, drawn in good faith against actually existing values, and the discounting of commercial paper actually owned by persons negotiating the same are not considered loans, and therefore, are not subject to any lending limitation.
B. National Banks
The applicable rule for national banks defines a “loan or extension of credit” as a bank’s direct or indirect advances of funds to or on behalf of a borrower based on an obligation of the borrower to repay the funds or repayable from specific property pledged by or on behalf of the borrower. Loans or extensions of credit also include: (1) a contractual commitment to advance funds; (2) a maker or endorser’s obligation arising from a bank’s discount of commercial paper; (3) a bank’s purchase of securities subject to an agreement that the seller will repurchase the securities at the end of a stated period; (4) a bank’s purchase of third-party paper subject to an agreement that the sell will repurchase the paper upon default or at the end of a stated period; (5) an overdraft, whether or not prearranged, but not an intra-day overdraft for which payment is received before the close of business of the bank that makes the funds available; (6) the sale of federal funds with a maturity of more than one business day, but not federal funds with a maturity of one day or less or federal funds sold under a continuing contract; and (7) loans or extensions of credit that have been charged off on the books of the bank in whole or in part, unless the loan or extension of credit (i) is enforceable by reason of discharge in bankruptcy; (ii) is no longer legally enforceable because of expiration of the statute of limitations or a judicial decision; or (iii) is no longer legally enforceable for other reasons, provided that the bank maintains sufficient records to demonstrate that the loan is unenforceable.
For purposes of determining a national bank’s lending limit, a “contractual commitment to advance funds” includes a bank’s obligation to: (1) make payment (directly or indirectly) to a third person contingent upon default by a customer of the bank in performing an obligation and to make such payment in keeping with the agreed upon terms of the customer’s contract with the third person, or to make payments upon some other stated condition; (2) guarantee or act a surety for the benefit of a person; (3) advance funds under a qualifying commitment to lend (a legally binding written commitment to lend that, when combined with all other outstanding loans and qualifying commitments to a borrower, was within the bank’s lending limit when entered into, and has not been disqualified); and (4) advance funds under a standby letter of credit, a put, or other similar arrangement.
III. COMBINATION AND ATTRIBUTION RULES
A. State Chartered Banks – Partnerships
In determining lending limits, partnerships are not being treated as separate entities. Each individual is charged with his or her personal debt plus the debt of every partnership in which he or she is a partner, except that (1) an individual is charged only with the debt of any limited partnership in which he or she is a partner to the extent that the terms of the limited partnership agreement provide that such individual is to be held liable for the debts or actions of such limited partnership; and (2) no individual is charged with the debt of any general partnership in which he or she is a partner beyond the extent to which (i) his or her liability for such partnership debt is limited by the terms of the contract or other written agreement between the bank and such individual and (ii) any personal debt of such individual is incurred for the use and benefit of such general partnership.
B. National Banks – Direct Benefit and Common Enterprise Tests
Extensions of credit to one person will be attributed to other people for purposes of the lending limit when: (1) the proceeds of the loan or extension of credit will be used for the “direct benefit” (the “direct benefit test”) of another person, to the extent of the proceeds so used; or (2) when a “common enterprise” (the “common enterprise test”) is deemed to exist between two or more persons. Satisfaction of the direct benefit test will clearly be present if the borrower transfers the proceeds of an extension of credit to some other person, however a loan may be required to be attributed to another person, even absent a direct transfer of funds, based upon the particular circumstances.
In determining whether a “common enterprise” exists, the following standards are used: (1) when the expected source of repayment for each loan or extension of credit is the same for each borrower and neither borrower has another source of income from which the loan (together with the borrower’s other obligations) may be fully repaid; (2) the borrowers are related directly or indirectly through common control, including where one borrower is directly or indirectly controlled by another borrower; and substantial financial interdependence exists between or among the borrowers (substantial financial interdependence is deemed to exist when 50% or more of one borrower’s gross receipts or gross expenditures (on an annual basis) are derived from transactions with the other borrower); (3) when separate persons borrow from a bank to acquire a business enterprise of which those borrowers will own more than 50% of the voting securities or voting interests; or (4) when the OCC determines, based upon an evaluation of the facts and circumstances of particular transactions, that a common enterprise exists.
C. Specific Examples
1. Loans to Corporations
Loans to a parent corporation and its subsidiary need not be combined unless the two companies are engaged in a “common enterprise” or unless the “direct benefits” test is satisfied. For purposes of this test, a corporation or a limited liability company is a subsidiary of any person that owns or beneficially owns more than 50% of the voting securities or voting interests of the corporation or company. Federal law (12 U.S.C. 84) limits the amount of loans and extensions of credit a national bank can make to any one borrower to 15% of a national bank’s unimpaired capital and surplus. A bank may lend an additional 10% if the credit is secured by readily marketable collateral.
2. Loans to Partnerships, Joint Ventures and Associations
Extensions of credit to a partnership, joint venture or association are considered extensions of credit to each member of the partnership, joint venture or association and must be combined with each individual’s outstanding loans in determining that individual’s lending limit.
3. Loans to Partners or Joint Ventures
Extensions of credit to members of a partnership, joint venture or association will only be attributed to the partnership, joint venture, association or other individual members thereof if the “direct benefit” or the “common enterprise” tests are met. Both the direct benefit and common enterprise tests are met between a member of a partnership, joint venture or association and such partnership, joint venture or association when loans or extensions of credit are made to the member to purchase an interest in the partnership, joint venture or association.
4. Loans to Limited Partnerships
Extensions of credit to a limited partnership are not deemed extensions to the individual partners as long as the terms of the partnership agreement do not hold the limited partner liable for the debts or actions of the partnership.
IV. EXCEPTIONS TO LENDING LIMITS
There are several lending limit exceptions for both state and national banks.
Nebraska law provides the following exceptions which are available for state banks:
1. Obligations in the form of notes or drafts secured by shipping documents or instruments transferring or securing title covering livestock or giving a lien on livestock, when the market value of the livestock securing the obligation is not at any time less than 115% of the face amount of the notes covered by such documents are subject to a limitation equal to 10% of such capital, surplus and capital notes and debentures or 10% of such unimpaired capital and unimpaired surplus, whichever is greater, in addition to such 25% of such capital and surplus or such 15% of such unimpaired capital and unimpaired surplus;
2. Obligations secured by not less than a like amount of bonds or notes of the United States issued since April 24, 1917, or certificates of indebtedness of the United States, Treasury Bills of the United States or obligations fully guaranteed both as to principal interest by the United States are subject to a limitation equal to 10% of such capital, surplus and capital notes and debentures or 10% of such unimpaired capital and unimpaired surplus, whichever is greater, in addition to such 25% of such capital and surplus or such 15% of such unimpaired capital and unimpaired surplus;
3. Obligations which are secured by negotiable warehouse receipts in an amount not less than 115% of the face amount of the note or notes secured by such documents are subject to a limitation of 10% of such capital, surplus and capital notes and debentures or 10% of such unimpaired capital and unimpaired surplus, whichever is greater, in addition to such 25% of such capital and surplus or such 15% of such unimpaired capital and unimpaired surplus;
4. Obligations which are secured by readily marketable collateral having a market value, as determined by reliable and continuously available price quotations, in an amount at least equal to the face amount of the note(s) secured are subject to a limitation of 10% of such capital, surplus and capital notes and debentures or 10% of such unimpaired capital and unimpaired surplus, whichever is greater, in addition to such 25% of such capital and surplus or such 15% of such unimpaired capital and unimpaired surplus;
5. Loans or obligations to the extent that they are secured or covered by guarantees, or by commitments or agreements to take over or to purchase the same made by any Federal Reserve Bank or by the United States Government or any authorized agency thereof, including any corporation wholly owned directly or indirectly by the United States or general obligations of any state of the United States or any political subdivision thereof;
6. A bank’s subscription to, investment in, purchase of and ownership of single-family mortgages secured by the Federal Home Association or the Veteran’s Administration and mortgage backed certificates of the Government National Mortgage Association which are guaranteed as to payment of principal and interest by the Government National Mortgage Association;
7. Obligations representing loans to any national banking association or to any banking institution organized under the laws of any state, when such loans are approved by the Director of Banking and Finance by regulations or otherwise;
8. Loans or extensions of credit secured by a segregated deposit account in the lending bank.
National banks also have exceptions to their lending limits for:
1. Loans or extensions of credit secured by bills of lading, warehouse receipts, or similar documents transferring or securing title to readily marketable staples, are subject to a limitation of 35% of the bank’s capital and surplus in addition to the general limitations, if the market value of the staples securing each additional loan or extension of credit at all times equals or exceeds 115% of the outstanding amount of the loan, that exceeds the bank’s combined general limit, such staples to be fully covered by insurance whenever customary;
2. Loans or extensions of credit that arise from the discount of negotiable or nonnegotiable installment consumer paper that carries a full recourse endorsement or unconditional guarantee by the person selling the paper, which may not exceed 10% of the bank’s capital and surplus in addition to the amount allowed under the bank’s combined general limit.
3. Loans or extensions of credit secured by shipping documents or instruments that transfer or secure title to or give a first lien on livestock may not exceed 10% of the bank’s capital and surplus in addition to the amount allowed under the bank’s combined general limit. The market value of the livestock securing the loan must at all times equal at least 115% of the amount of the outstanding loan that exceeds the bank’s combined general limit. The term “livestock” includes dairy and beef cattle, hogs, sheep, goats, horses, mules, poultry and fish, whether or not held for resale. (The bank must maintain in its files an inspection and valuation for the livestock pledged that is reasonably current, taking into account the nature and frequency of turnover of the livestock to which the documents relate, but in any case not more than twelve months old.)
4. Loans and extensions of credit which arise from the discount by dealers in dairy cattle of paper given in payment for dairy cattle may not exceed 10% of the bank’s capital and surplus in addition to the amount allowed under the bank’s combined general limit.
5. Additional advances to complete project financing pursuant to renewal of a qualifying commitment to lend if (a) the completion of funding is consistent with safe and sound banking practices and is made to protect the position of the bank; (b) the completion of funding will enable the borrower to complete the project for which the qualifying commitment to lend was made; and (c) the amount of the additional funding does not exceed the unfunded portion of the bank’s qualifying commitment to lend.
The following loans or extensions of credit are not subject to the national bank lending limits:
1. Loans or extension of credit arising from the discount of negotiable commercial or business paper that evidences an obligation to the person negotiating it with recourse;
2. The purchase of certain bankers’ acceptances issued by other banks that are eligible for rediscount;
3. Loans or extensions of credit, or portions thereof, to the extent fully secured by the current market value of: (a) bonds, notes, certificates of indebtedness, or Treasury bills of the United States or by similar obligations fully guaranteed as to principal and interest by the United States; (b) loans to the extent guaranteed as to repayment of principal by the full faith and credit of the U.S. Government (to qualify under these provisions, the bank must perfect a security interest in the collateral under applicable law);
4. Loans or extensions of credit to any department, agency, bureau, board, commission, or establishment of the United States or any corporation wholly-owned directly or indirectly by the United States;
5. Loans or extensions of credit, including portions thereof, to the extent secured by unconditional takeout commitments or guarantees of any of the governmental entities described in number 4 above;
6. Loans or extensions of credit to a state or political subdivision that constitutes a general obligation of the state or political subdivision that constitutes a general obligation of the state or political subdivision, and for which the lending bank has obtained the opinion of counsel that the loan or extension of credit is a valid and enforceable general obligation of the borrower;
7. Loans or extensions of credit, including portions thereof, to the extent secured by a segregated deposit account in the lending bank provided a security interest in the deposit has been perfected under applicable law (where the deposit is eligible for withdrawal before the secured loan matures, the bank must establish internal procedures to prevent release of the security without the lending bank’s prior consent;
8. Loans or extensions of credit to any financial institution or to any receiver, conservator, superintendent of banks, or other agent in charge of the business and property of such financial institution when an emergency situation exists and a national bank is asked to provide assistance to another financial institution, and the loan is approved by the Comptroller;
9. Loans or extensions of credit to the Student Loan Marketing Association;
10. Loans or extensions of credit to an industrial development authority or similar public entity created to construct and lease a plant facility, including a health care facility, to an industrial occupant;
11. Loans or extension of credit to a leasing company for the purpose of purchasing equipment for lease.
V. COMMITMENTS TO ADVANCE FUNDS
When a bank makes a commitment to advance funds to a borrower, which funds can be drawn upon at any time by the borrower, the total amount of that commitment is combined with the borrower’s loans for the purposes of the lending limit. Examples are discussed below.
A. Bank Credit Cards
Bank credit cards are preapproved lines of credit made by the bank to a borrower. For this reason, all credit card limits will be combined with any other loans made to a cardholder when determining whether loans made to a borrower are within the bank’s lending limit. NOTE: If cards are issued to a state chartered bank executive officer, care must be taken that such card limits when combined with personal borrowings do not exceed the limits for executive officers contained in Neb.Rev.Stat. § 8-143.01.
B. Overdraft or Checking Plus Agreements
In overdraft agreements or checking plus agreements, the bank is committed to extend funds to cover insufficient fund checks written by customers. They are a type of loan, and must be combined with all other types of debt for the purposes of bank’s loan limit to a borrower. Like credit cards, the key is the amount of funds the bank is committed to extend, not whether funds have actually been advanced.
C. Master Notes
Where the bank uses a master note which unconditionally obligates the bank to extend a line of credit to a borrower, the amount considered advanced for lending limit purposes is the total amount which may be drawn, whether actually advanced or not. Therefore, it will be considered a violation of the bank’s lending limit if the bank writes such a master note in excess of their lending limit on that date, even though the funds are not actually advanced. In order to avoid such a violation, the bank would need an irrevocable participation agreement from another financial institution effective the same day as the master note.
D. Letters of Credit
Letters of credit are commitments by the bank to advance funds on behalf of a borrower, and as such, must be combined with any outstanding loans to the borrower.
VI. PENALTIES AND INDIVIDUAL LIABILITY
For state banks, any officer or employee of any bank who shall violate or knowingly permit a violation of the provisions of § 8-141 shall be guilty of a Class IV misdemeanor. If the directors of any bank shall violate or knowingly permit any of the officers, agents or servants of the bank to violate any of the provisions of § 8-141, all rights, privileges and franchises of the bank shall be forfeited. Every director who participated in or knowingly assented to a violation of § 8-141 shall be held liable in his personal and individual capacity for all damages which the bank, its shareholders or any other person shall have sustained as a consequence of the violation.
For national banks, the directors of a bank may be held jointly and severally liable as individuals to the shareholders for the full amount of any loan loss which occurs do to loans made in excess of the bank’s lending limit. National banks are subject to a civil penalty of up to $5,000 a day plus the possible loss of the rights, privileges and franchises of the bank for violation of their lending limit. In addition, the FDIC considers the exceeding of a bank’s lending limit to constitute unsafe and unsound banking practices which can result in the loss of FDIC insurance.
C. How May a Violation of the Bank’s Lending Limit be Cured?
While the state law is silent on the subject of curing a violation of the bank’s lending limit, there is some guidance for national banks in this area. The monetary penalty which may be imposed upon a bank may be terminated once the offending loan is reduced to an amount less than the bank’s lending limit. It appears however, that the director’s potential individual liability for losses on loans exceeding the lending limit may only be removed when the loan which caused the violation is paid in full.
VII. LENDING LIMITS WHERE BANK’S CAPITAL DECLINES
Neb.Rev.Stat. § 8-141 allows a state chartered bank that has experienced a decline in capital (thereby lowering its lending limit), to renew, extend or service existing loans which would otherwise be in excess of the bank’s current lending limit.
In 1987, Congress enacted and the President signed the Competitive Equality Banking Act in which banking regulators were granted authority to provide, upon bank application to the OCC or FDIC, for substitute lending limits for certain banks which had been adversely affected by reductions in capital because of agricultural and energy-related loans.
OCC regulations are intended to afford relief to national banks that have experienced a decline in capital, and hence, in their lending limit, after entering into a legally binding loan commitment. Under the OCC’s rule, when a national bank makes a commitment to lend money, but does not actually advance the funds, the commitment is treated as a loan made at the time the bank made the commitment, which may be subsequently funded, provided the amount of the commitment, when combined with all other outstanding loans and qualifying commitments to the borrower, is within the bank’s lending limit on the date it is executed. Should the bank’s capital, and thus its lending limit subsequently decline, the bank will not violate its lending limit when it actually funds the loan.
The OCC rule also allows national banks to make “overline” loan commitments (loan commitments which would exceed the bank’s lending limit if funded on the date of execution). For overline loan commitments, the bank’s lending limit is calculated on the day funds are advanced, even if capital is subsequently reduced. Therefore, such commitments may be funded only if, on the date of funding, monies advanced, combined with all other outstanding loans and qualifying commitments to the borrower, would not exceed the banks lending limit.
As an example, consider a bank that on June 1, 1991, has a lending limit of $1 million, with outstanding loans to a borrower of $900,000. On June 1, the bank enters into a legally binding written loan commitment to loan borrower an additional $100,000. The term of the commitment is one year, to be funded at a later date. On June 30, 1991, the banks capital has decreased and its lending limit has shrunk to $950,000. Because this loan commitment, when combined with all other outstanding loans and qualifying commitments to the borrower was within the banks lending limit when made, the commitment qualifies as a loan which may be funded, even though the bank’s lending limit subsequently declined and the total now exceeds the limit. If in July, after the bank’s lending limit has declined to $950,000, the borrower requests the bank to fund its June loan commitment, the bank may fund the commitment without violating its lending limits. However, the amount extended in excess of its then existing lending limit ($50,000) would be deemed non-conforming. If the borrower subsequently in September requests a short term loan of $100,000 from the bank, the bank may not make the loan without violating its lending limits because it has non-conforming extensions of credit outstanding to the borrower at that time.
Once the commitment expires, if it has not been funded, the bank should not renew it for the full amount if that amount would now exceed the banks lending limit. The final regulation provided that the renewal of an unfunded commitment in excess of the bank’s lending limit, or the renewal of the unfunded portion of a loan commitment in excess of the bank’s lending limit, could create lending limit problems for the bank. Under these circumstances, instead of treating the renewal of the commitment as a loan, the regulators will instead wait to see what the banks circumstances are at the time the funds are actually advanced in order to determine, as of THAT date, whether a lending limit violation has occurred.
As an example, consider a bank with a lending limit of $1 million on June 1, 1991. The bank enters into a legally binding written loan commitment to loan the borrower $1 million. The term of the commitment is 6 months. Following the expiration of the original commitment, the bank renews the commitment on December 1, at a time when the bank’s lending limit has decreased to $900,000. Rather than treating the renewal of this commitment as an immediate violation, the regulators will wait to determine what the banks lending limit is on the date funds are actually advanced pursuant to the commitment. A lending limit violation will occur if, on the date of funding, the borrower is advanced funds under the commitment which exceed the bank’s then existing lending limit.
In order to avoid potential lending limit violations in connection with renewals of commitments, the OCC recommends that banks protect themselves by building in contractual provisions in the commitment which allow the bank to be released from its obligation, if funding the loan commitment would result in a violation of the bank’s lending limit.
VIII. WHEN A QUALIFYING COMMITMENT IS NOT A LOAN
Sometimes it may be to the bank’s advantage to have a loan commitment, which would otherwise be treated as a loan, disqualified from that treatment. For example, if the bank has several outstanding loan commitments to a borrower, it could reach its lending limit to that borrower without having advanced funds to him. This occurs because once a commitment is treated as qualifying as a loan, it would have to be included by the bank in its computation of its lending limit for all subsequent loans to the borrower. No additional loans could be made to the borrower under those circumstances without violating the lending limit. For that reason, the final rule allows commitments which automatically qualify as loans to be disqualified if, after entering into a qualifying commitment, the bank makes an addition loan or an extension of credit to the borrower which exceeds the banks lending limit when combined with all other outstanding loans and qualifying commitments to the borrower. Remember, once a loan commitment has been disqualified, it will be treated as just a commitment - not a loan. Therefore, when it is ultimately funded, it must be within the lending limit as of the date of funding.
As an example, consider a bank with a lending limit of $1 million which has entered into two separate binding written loan commitments to loan the borrower $1 million ($500,000 for each commitment). Both commitments relate to specific projects and neither has been funded. Borrower subsequently comes to the bank asking for an $800,000 loan on an unrelated project. If the two original commitments were to be treated as loans, the bank would be deemed to have “loaned” the borrower $1 million previously, thus precluding the bank from loaning borrower additional funds. However, since the original commitments were not funded, they may be disqualified from being considered loans and a new loan could be made in an amount up to the banks lending limit without incurring a lending limit violation.
IX. LOAN PURCHASE ACTIVITIES
A. National Banks
The Office of the Comptroller of the Currency (OCC) has issued a bulletin to provide banks with guidance regarding the applicability of the legal lending limit (LLL) to purchased loans.
The bulletin provides: a) background information on loan purchase activities and the LLL; and b) guidance on the applicability of the LLL to purchased loans and types of recourse arrangements.
1. Background
Unless an exception applies, all loans and extensions of credit made by banks are subject to the LLL, which provides limitations on the total amount of loans and extensions of credit to any one borrower. Whether a loan that a bank purchases is attributable to the seller under the LLL regulation depends on specific facts and circumstances. Consequently, bank management would typically consider more information than it would for in-house originations when determining compliance with the LLL regulation for purchased loans.
2. Guidance
Aggregate exposures attributable to a single seller must be within the bank’s LLL. Loans are attributable to a seller under 12 CFR 32.2(q)(1)(iii) if the bank has direct or indirect recourse to the seller. Direct or indirect recourse can be explicit or implied. Explicit recourse is generally provided under contractual arrangement or other written agreement between the bank and the seller. Implied recourse is established through the bank’s course of dealing or conduct with a seller even if the contract or written agreement with the provider does not contain explicit recourse.
The following are examples of explicit and implied recourse scenarios:
If the bank does not have explicit or implied recourse to the seller, the loans are generally not attributable to the seller under 12 CFR 32.2(q)(1)(iii). In such cases, the purchased loans would generally be attributable under the LLL regulation to only the named borrowers on the loans, unless the direct benefit or common enterprise tests under 12 CFR 32.5 are met or other provisions under the LLL regulation warrant attribution to another party.