April 12, 1999
RE: Net Lease and Purchase Agreement
Dear [ ]:
This is in response to your letter dated April 7, 1999 in which you inquire as to whether a New York state-chartered commercial bank may offer a net lease home finance product. For reference, you enclosed a copy of Interpretive Letter No. 806 issued by the Comptroller of the Currency dated October 17, 1997. The purpose of the net lease home finance product is to meet the needs of Islamic customers, who, for religious reasons, cannot borrow money if the lender charges interest.
While you do not describe in your letter how the net lease home finance product will be structured, I am assuming, for the purposes of this letter, that it will operate in the same manner as the Net Lease and Purchase Agreement described in the Interpretive Letter cited above. To wit, the lessee will contract with the seller to buy a single-family residence and will tender a down payment toward such purchase. Before funding the remainder of the purchase price, the bank and the lessee will simultaneously enter into a Net lease Agreement and a Purchase Agreement.
The bank as lessor will make no representations or warranties regarding the property or its suitability. It will supply the remainder of the funds to purchase the property from the seller and have "legal title" to the property. The bank will record its interest in the property as it would record a "traditional" mortgage. Furthermore, the bank will not purchase or maintain an inventory of properties to sell to customers. Rather, a potential lessee will be required to find the property that he or she wishes to purchase and to negotiate the terms will the seller.
The Net Lease will allow the lessee to occupy the property for a specified number of years, in return for which the lessee must maintain the property and pay expenses attributable to property ownership. The monthly lease payments will be sufficient to cover principal and interest, insurance and property taxes. The entire principal will be amortized by the end of the lease term and the lessee will automatically become the legal owner of the property upon fulfilling the terms of the lease. In the event of a default under the lease, the lender has the same remedies available as in a "traditional" nonrecourse mortgage.
The Banking Department has no objection to a lender entering into a proposal such as the one described above. We agree with the Office of the Comptroller of the Currency that this is "functionally equivalent to or a logical outgrowth" of secured real estate lending or mortgage lending, activities that are part of the traditional business of banking. The risks associated with the Net Lease proposal are essentially the same as those associated with underwriting "traditional" mortgage loans. Moreover, such activities would certainly come within the incidental powers clause found in Banking Law section 96(1). However, we do suggest that the bank should carefully consider and address for itself any special liability that could arise from its long-term nominal ownership of the property.
I trust that this responds to your inquiry.
Very truly yours,