To: Examiner McEnerney, Domestic Commercial Banks Division
From: Assistant Counsel Kane, Legal Division
Date: May 17, 2000
Subject: [ ] - Capital Calculation for Legal Lending Limit
Your request to Sara Kelsey has been referred to me. Several issues relating to determining the legal lending limit of [ ] ("Bank") have arisen in connection with the Bank's planned acquisition of [ ]In calculating the legal lending limit under Section 103(1) of the Banking Law you ask if the Bank may: (a) include goodwill resulting from the Bank's use of "push-down" accounting in connection its acquisition of[ ]; (b) exclude the unallocated balance arising from the Bank's Employee Stock Ownership Plan ("ESOP"); and (c) exclude net unrealized losses on available-for-sale ("AFS") securities. In addition, you have asked whether the Bank's legal lending limit is calculated on its stand- alone basis or is aggregated with that of [ ]
You have inquired whether the Bank, which takes the view that it is subject to "push-down" accounting in connection with its acquisition of [ ] may include the goodwill generated by employing that accounting method for purposes of calculating its legal lending limit. Under push down accounting, when a depository institution is acquired in a purchase (but not in a pooling of interests), yet retains its separate corporate existence, the assets and liabilities of the acquired institution are restated to their fair values as of the acquisition date. These values, including any goodwill, are reflected in the separate financial statements of the acquired institution as well as in any consolidated financial statements of the institution's parent. In other words, goodwill is not permitted to be aggregated with other assets.
The Bank is subject to the lending limits contained in Section 103 of the Banking Law. Section 103(1)(a) provides that no bank shall lend to any person, individual, partnership, unincorporated association, corporation or body politic an amount which will exceed fifteen percent of the capital stock, surplus fund and undivided profits of such bank, subject to certain exceptions contained therein, most notably an additional ten percent allowed for fully collateralized loans.
The term "capital stock" is defined in Section 2(22) of the Banking Law to mean the aggregate par value of all outstanding shares of every class. A "surplus fund" is defined in Section 110 of the Banking Law as consisting of contributions, by transfers from undivided profits, or from net profits. The term "undivided profits" is defined in Supervisory Procedure CB 120 to include paid-in or earned profits (unearned income must be deducted); reserves for loan losses or bad debts; valuation reserves for securities; and reserves for contingencies. It does not include reserves for dividends declared or reserves for taxes, interest and expenses.
The calculation of "net profits" is governed by Section 109 of the Banking Law, which specifies certain inclusions and deductions which are to be taken to determine gross income in order to compute net profits. Neither goodwill nor unrealized net gain or loss on securities available or held for sale are included in the calculation of gross income under this Section.
All of these definitions, taken together, specify those balance sheet items which are to be included within the definition of "capital stock, surplus fund and undivided profits," the denominator for purposes of the lending limit calculation. This definition does not include goodwill, nor has the Banking Department ever included goodwill within its definition by regulation or interpretation. Thus, goodwill would not be included in "capital stock, surplus fund and undivided profits" for purposes of calculating a bank's lending limit.
You have inquired whether the Bank should include the "unallocated" (i.e. not yet earned or distributed) ESOP balance when calculating the Bank's legal lending limit since the inclusion of this amount would result in a decrease. A review of the applicable State laws and regulations has uncovered no answer as to whether an ESOP must be included in determining the Bank's legal lending limits.
However, the Board of Governors of the Federal Reserve System ("Board") in their advisory "Review Procedures for ESOP Applications"' described ESOPs as serving "[a]s a vehicle of corporate finance whereby the employer raises additional capital. In purchasing employer stock, the ESOP, may, to the extent consistent with applicable regulations and standards, borrow necessary funds to purchase employer stock. Furthermore, it may purchase the stock either from the employer company or from shareholders." The applicable regulations and standards are set forth in the Internal Revenue Code and the Department of Labor regulations. The advisory is silent, however, as--to how a-bank, which establishes an ESOP, should account for the unallocated balance of an ESOP.
However, the Board's definition that an ESOP has the powers to contract and borrow money makes clear that an ESOP has a legal status akin to that of any individual, partnership or corporate borrower of the Bank and as such the ESOP, like any other borrower is subject to the 15 percent limitation governing loans or extensions of credit to one borrower contained in Section 103(1), and thus establishing the appropriate reserves. To the best of our knowledge, no section of the Banking Law, or rule or regulation enacted thereunder, requires the Bank to take into account the unallocated ESOP balance when calculating its legal lending limit.
C. Available-for-Sale Securities
You have asked whether the Bank must include net unrealized losses on AFS securities. As outlined above, neither unrealized losses nor unrealized gains on AFS securities are included in the calculation of "gross income" under Section 109 of the Banking Law and therefore are not included in the calculation of "capital stock, surplus fund and undivided profits."
D. Lending Limits for the Bank and [ ]
You have asked whether the Bank after acquiring [ ] should aggregate its lending limit with [ ] since both the Bank and [ ] will retain their individual charters. The aggregation provisions contained in Section 103(1) of the Banking Law are solely applicable to a bank's loans or extensions of credit to a borrower and related entities. They do not provide for aggregation of lending limits by banks whether or not they are related by virtue of their being owned by the same holding company. Thus, each separate bank maintains its individual legal lending limit.
1 SR-85-21(SA), dated July 31, 1985; CCH Federal Banking Law Reports 137-719.