Reminders for Your Regulation O Program
Odds are you’re familiar with Regulation O (Reg O) and its requirements, and you probably have experience making, tracking, and monitoring loans to insiders. In this article, we will review the key requirements of Reg O.
According to Section 215.2, an insider is an executive officer, director, principal shareholder, or any related interest of such person. The regulation defines extension of credit as the making or renewing of a loan, granting a line of credit, or extending credit in any manner. The regulation goes on to list specific examples of extensions of credit and further gives specific examples of what would not constitute an extension of credit. A purchase under a repurchase agreement of securities, issuance of a standby letter of credit, and advance of unearned salary are all included as extensions of credits. Continuing with the definitions in §215.2, an executive officer is defined as any person who participates or has authority to participate in major policymaking decisions of the institution.
In §215.4, four categories of prohibitions are listed for loans made to insiders of an institution:
- Terms and creditworthiness: An institution may not make a loan to an insider unless made on substantially the same terms and following the same credit underwriting procedures as comparable transactions. As a best practice, this should be documented on the loan underwriting memo.
- Prior approval: The bank must not extend credit that exceeds the higher of $25,000 or 5 percent of unimpaired capital and unimpaired surplus (not to exceed $500,000) unless:
- It has been approved in advance by the majority of the board
- The interested party has abstained from voting (again, this should be explicitly documented)
- Individual lending limit: No bank shall lend to an insider in an amount that, when aggregated with all other extensions of credit to that person, exceeds the lending limit of the bank.
- Aggregate lending limit: The bank may not lend to any insider unless the extension of credit does not exceed unimpaired capital and unimpaired surplus.
As a reminder, executive officers should be designated annually within the board minutes of a financial institution by listing each executive officer by name or title in the minutes, or by referring to an annual resolution that lists each officer included as an executive officer. Loans to executive officers bear additional requirements. According to §215.5, extensions of credit made to executive officers must be promptly reported to the board of directors, preceded by a detailed financial statement; also include the condition that “the loan may become due and payable at any time the officer is indebted to any other bank or banks in an aggregate amount greater than the amount specified in a category of credit” (a demand clause). One important item to note here is that there are no exceptions noted in this section of the regulation from the three aforementioned requirements.
Loans to executive officers can be made in the following three circumstances:
- For the education of the executive officer’s children.
- To finance or refinance the purchase, construction, or improvement of a residence of the executive officer. The extension of credit must be secured by a first lien on the residence and owned by the executive officer. For a refinance of the residence, funds advanced to an executive officer must be used to repay the original amount, be used for closing costs of the refinancing, or be used for the maintenance or improvement of the residence.
- For any other purpose, limited to $100,000.
The final key area of Reg O is overdrafts, which can only be made if under a written, preauthorized interest-bearing extension of credit or a written, preauthorized transfer of funds from another account. Otherwise, the overdraft must be inadvertent. For an overdraft to be considered inadvertent, it must be for $1,000 or less, not be overdrawn for more than five days, and the insider must be charged a fee. The bank should establish procedures to review insider items presented for payment in excess of the insider’s account balance to ensure accounts are not paid into overdraft exceeding $1,000 and monitor that they are paid within five days.
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