Alert May 05, 2009

OCC Issues Interpretive Letter Regarding Affiliate Lease of Aircraft

The OCC issued an Interpretive Letter (“Letter #1114”), regarding the applicability of Section 23A (“Section 23A”) of the Federal Reserve Act (the “Act”), and the FRB’s Regulation W, (“Regulation W”) to the lease of an aircraft by an operating subsidiary of a national bank (the “Bank”) to the Bank’s holding company (the “BHC”).  The BHC, a major foreign financial services holding company, owned the aircraft; however, for tax and other reasons, the Bank stated that it would be advantageous if the Bank owned the aircraft and leased it to the BHC.  The aircraft had a fair market value of $20 million.  Under the proposed lease transaction, the Bank would form the operating subsidiary, which would then purchase the aircraft from the BHC for $19 million.  The lease would be structured to satisfy the requirements of 12 U.S.C. § 24(Tenth), which prohibits a national bank from investing in tangible personal property for lease financing transactions on a net lease basis if such investment exceeds 10 percent of the assets of the national bank.  The term of the lease would be five years with a possibility of renewal.  The monthly lease payments would be $200,000.  The Bank asked what the value of the transaction would be and whether the leased aircraft could be treated as collateral for purposes of Section 23A.

Value of Transaction.  The OCC concluded in Letter #1114 that the lease would be treated as a loan or extension of credit to an affiliate that is subject to Section 23A and Section 23B of the Act.  Therefore, the OCC determined, the lease was a “covered transaction” under Section 23A subject to capital-based quantitative limits.  Regulation W provides three options for the valuation of a credit transaction: (i) the principal amount of the transaction; (ii) the amount owed by the affiliate to the member bank under the transaction; or (iii) the sum of – (A) the amount provided to, or on behalf of, the affiliate in the transaction; and (B) any additional amount that the member bank could be required to provide to, or on behalf of, the affiliate under the terms of the transaction.  The OCC concluded that the value of the transaction at issue was the “amount provided to…the affiliate in the transaction,” which in this case was the book value of the aircraft, or $20 million.  The OCC further noted that the $1 million difference between the fair market value of the aircraft and the purchase price should be accounted for as a contribution to capital.

Collateral.  Section 23A requires a member bank to obtain collateral equaling 100 to 130 percent of a loan or extension of credit to an affiliate, depending on the type of collateral received.  The OCC concluded that the leased aircraft should be considered collateral for purposes of Section 23A, noting that in the case of a lease, “the lessor actually has a better form of security than [Regulation W] requires – ownership of the property, as opposed to a mere security interest” and that “[t]reating the leased property as collateral for purposes of section 23A makes economic and practical sense while still upholding the safety and soundness concerns behind section 23A’s collateral requirement.”  The amount of collateral that Section 23A requires for personal property, such as the aircraft, is 130 percent.  Because in round numbers, $20 million is 130 percent of $15,385,000, Letter #1114 states that the BHC would need to provide the Bank with $4,615,000 in additional collateral.