Activities and Investments of Insured State Banks

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 362

RIN 3064-AA29

Activities and Investments of Insured State Banks

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Proposed rule.

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SUMMARY: The FDIC is proposing to amend its regulations governing the

activities and investments of insured state banks. In general, subject

to certain exceptions, insured state banks are prohibited from making

equity investments of a type and in an amount that are not permissible

for national banks or engaging as principal in activities of a type not

permissible for national banks. The regulation requires banks to file

with the FDIC their plan for the divestiture of any prohibited equity

investments, establishes procedures regarding notices to the FDIC

pertaining to excepted equity investments, delegates authority to act

on notices, applications and divestiture plans, requires that banks

provide certain information to the FDIC regarding existing insurance

underwriting activities that the law allowed banks to continue,

provides for application procedures to obtain consent to engage in

otherwise impermissible activities, and establishes a number of

exceptions to required consent. The proposed amendment substitutes a

notice for an application when banks meet specified requirements for

particular real estate, life insurance and annuity investment

activities. If the FDIC does not object to the notice during the notice

period, the bank may proceed with the planned investment activities.

DATES: Comments must be received by October 22, 1996.

ADDRESSES: Send comments to Jerry L. Langley, Executive Secretary,

Federal Deposit Insurance Corporation, 550 17th Street N.W.,

Washington, D.C. 20429. Comments may be hand delivered to room F-402,

1776 F Street N.W., Washington, D.C. on business days between 8:30 a.m.

and 5 p.m. Comments may be sent through facsimile to: (202) 898-3838 or

by the Internet to: [email protected]. Comments will be available for

inspection at the FDIC Public Information Center, room 100, 801 17th

Street, N.W., Washington, D.C. on business days between 9:00 a.m. and

4:30 p.m.

FOR FURTHER INFORMATION CONTACT: Shirley K. Basse, Review Examiner,

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(202) 898-6815, Division of Supervision, FDIC, 550 17th Street, N.W.,

Washington, D.C. 20429; Pamela E.F. LeCren, Senior Counsel, (202) 898-

3730, Patrick J. McCarty, Counsel, (202) 898-8708 or Linda L. Stamp,

Counsel, (202) 898-7310, Legal Division, FDIC, 550 17th Street, N.W.,

Washington, D.C. 20429.

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in part 362 has been

approved by the Office of Management and Budget under control number

3064-0111 pursuant to section 3504(h) of the Paperwork Reduction Act

(44 U.S.C. 3501 et seq.). Comments on the collection of information

should be directed to the Office of Information and Regulatory Affairs,

Office of Management and Budget, Washington, D.C. 20503, Attention:

Desk officer for the Federal Deposit Insurance Corporation, with copies

of such comments to be sent to Steven F. Hanft, Office of the Executive

Secretary, room F-453, Federal Deposit Insurance Corporation, 550 17th

Street, NW, Washington, D.C. 20429. The collection of information in

this amended regulation is found in Sec. 362.4(c)(3)(vi) and

Sec. 362.4(c)(3)(vii) and takes the form of a 60 day advance notice to

be filed by an insured state bank that meets certain requirements and

intends to: (1) invest, indirectly through a majority-owned subsidiary,

in real estate investment activities; and/or (2) directly, or

indirectly through a majority-owned subsidiary, invest in insurance

products or annuity contracts. The information will allow the FDIC to

properly discharge its responsibilities under section 24 of the Federal

Deposit Insurance Corporation Act (12 U.S.C. 1831a). The information in

the notices will be used by the FDIC to ensure compliance with the law,

as part of the process of determining risk to the deposit insurance

funds.

Notice to Indirectly Engage as Principal in Real Estate Investment

Activities

Number of Respondents: 250.

Number of Responses Per Respondent: 1

Total Annual Responses: 250

Hours Per Response: 6

Total Annual Burden Hours: 1,500

Notice to Directly or Indirectly Acquire or Retain Life Insurance

Products or Annuity Contracts

Number of Respondents: 60.

Number of Responses Per Respondent: 1.

Total Annual Responses: 60.

Hours Per Response: 4.

Total Annual Burden Hours: 240.

Background

On December 19, 1991, the Federal Deposit Insurance Corporation

Improvement Act of 1991 (FDICIA) (Pub. L. 102-242, 105 Stat. 2236) was

signed into law. Section 303 of FDICIA added section 24 to the Federal

Deposit Insurance Act (FDI Act), ``Activities of Insured State Banks''

(12 U.S.C. 1831a). With certain exceptions, section 24 of the Federal

Deposit Insurance Act (FDI Act) limits the direct equity investments of

state chartered insured banks to equity investments of a type and in an

amount that are permissible for national banks. In addition, the

statute prohibits an insured state bank from directly, or indirectly

through a subsidiary, engaging as principal in any activity that is not

permissible for a national bank unless the bank meets its capital

requirements and the FDIC determines that the activity will not pose a

significant risk to the deposit insurance fund. Section 24 provides

that the FDIC may make such determinations by regulation or order. The

statute requires that equity investments that do not conform to the new

requirements must be divested no later than December 19, 1996 and

requires that banks file certain notices with the FDIC concerning

grandfathered investments.

Part 362 of the FDIC's regulations (12 CFR part 362) implements the

provisions of section 24 of the FDI Act. Among other things, part 362

sets out application procedures whereby insured state banks may seek

the FDIC's consent to engage in otherwise impermissible activities. The

FDIC may impose such conditions and restrictions on the approval of any

application as it deems necessary to prevent the conduct of the

activity from posing a significant risk to the deposit insurance fund.

Part 362 also provides for certain exceptions which allow adequately-

capitalized insured state banks to engage in named activities without

prior consent as the FDIC has determined that engaging in the

activities in question does not present a significant risk to the

insurance fund.

Between 1992 and April 30, 1996, the FDIC acted on 1156

applications, notices and divestiture plans under section 24 either by

action of the Board of Directors or by the Division of Supervision

pursuant to delegated authority. The majority of the filings were

notices and divestiture plans. The applications submitted for Board

action have for the most part involved indirect equity interests in

real estate (i.e. a majority-owned subsidiary holds or would hold the

real estate investment) and direct investments in life insurance

policies and annuities. The FDIC has evaluated these applications with

a view toward developing a proper balance between minimizing risk to

the deposit insurance funds and allowing state banks to engage in real

estate, insurance and annuity investment activities where otherwise

permitted under state law.

Of the applications, notices and divestiture plans filed under

section 24 and part 362, the Board acted on 34 applications to directly

or indirectly initiate or continue as principal an impermissible

activity, approving 31 applications. The Division of Supervision acted

on a total of 1122 applications and/or notices which consisted of the

following: 388 requests to directly or indirectly initiate or continue

as principal in an impermissible activity; 460 notices regarding

grandfathered investments in common or preferred stock or shares of an

investment company (which includes plans for divestitures of the excess

investments in the products); 272 divestiture plans regarding

impermissible equity investments and impermissible activities; and 2

requests to retain an equity investment in an insurance underwriting

department. Of these filings, 5 applications were denied either in

whole or in part.

Based on the agency's experience with the applications to date, the

FDIC proposes to amend part 362 to substitute a notice procedure for

prior approval by application in the case of real estate investment,

life insurance and annuity investment activities provided the banks

meet certain conditions and restrictions. Under the proposed amendment,

if the FDIC does not object to the notice within a maximum period of 90

days (60 days initial period plus 30 day optional extension), the bank

may proceed with its investment activity as planned. The agency's

experience to date with real estate, insurance and annuity investment

activities is discussed below along with a discussion of the risks

associated with these types of investment activities. A detailed

discussion of the proposed notice provisions follows.

Real Estate Investment Activities

The circumstances under which national banks may hold equity

investments in real estate are limited. If a particular real estate

investment is permissible for a national bank, a state bank only needs

to document that determination. If a particular real estate investment

is not permissible for a national bank and a state bank wants to

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engage in real estate investment activities (or continue to hold the

real estate investment in the case of investments acquired before

enactment of section 24 of the FDI Act), the bank must file an

application with FDIC for consent. The FDIC may approve such

applications if the investment is made through a majority-owned

subsidiary, the institution is well capitalized and the FDIC determines

that the activity does not pose a significant risk to the deposit

insurance fund.

The FDIC approved 63 of 66 applications from December 1992 through

April 30, 1996 involving real estate investment activities. The FDIC

denied one application, approved one in part, and one bank withdrew its

application. The real estate investment applications generally have

fallen into three categories: (1) Requests for consent to hold real

estate at the subsidiary level while liquidating the property where the

bank expects that liquidation will be completed later than December 19,

1996; (2) requests for consent to continue to engage in real estate

investment activity in a subsidiary, where such activities were

initiated prior to enactment of section 24 of the FDI Act; and (3)

requests for consent to initiate for the first time real estate

investment activities through a majority-owned subsidiary.

The approved applications have involved investments which have

ranged from less than 1% to over 70% of the bank's Tier 1 capital. The

majority of the investments, however, involved investments of less than

10% of Tier 1 capital with only four applications involving investments

exceeding 25% of Tier 1 capital. The applications filed with the FDIC

have involved a range of real estate investments including holding

residential properties, commercial properties, raw land, the

development of both residential and commercial properties, and leasing

of previously improved property. The applications FDIC approved

included 21 residential properties, 29 commercial properties and 13

applications covering a mix of commercial and residential properties.

The assets of the institutions that submitted approved applications

ranged from $15 million to $6.7 billion. The institutions which have

been approved to continue or commence new real estate investment

activity primarily have had composite ratings of 1 or 2 ratings under

the Uniform Financial Institution Rating System (UFIRS). However, 2

institutions were rated 3 and 2 institutions were rated 4. The 4-rated

institutions submitted applications to continue an orderly divestiture

of real estate investments after December 19, 1996. Of the approved

applications, 6 were to conduct new real estate investment activities,

while 54 were submitted to continue holding existing real estate or to

hold existing real estate after December 19, 1996 in order to pursue an

orderly liquidation. The remaining 3 approved applications asked for

consent to continue existing holdings and conduct new real estate

activities. One application was partially approved and partially

denied. This application involved a bank that applied for consent to

continue direct real estate activities and consent to continue indirect

real estate investment activities through a subsidiary. The FDIC

approved the application to continue the real estate investment

activity through the subsidiary and denied the application for the bank

to engage directly in real estate investment activities.

In connection with the review of the above described applications,

the FDIC undertook to determine what risk, if any, real estate

investments pose to banks and ultimately to the deposit insurance

funds. After reviewing, among other things, whether and to what extent

real estate investments have played a role in the failure of

institutions, the FDIC determined that real estate investments can pose

significant risks, and that if such activities are to be permitted,

prudential constraints should be imposed to control the various risks

posed to both a financial institution and the deposit insurance fund.

The results of that review are summarized below.

Risks of Real Estate Investment Activities

Investments in real estate, at any stage of the development

process, or even completed properties, generally can be characterized

as risky in that there is a high degree of variability or uncertainty

of returns on invested funds. The cyclical downturn in the real estate

market in the late 1980s and early 1990s, and the impact of that

downturn on financial institutions, provides an illustration of the

market risk presented by real estate investment activities. In addition

to the high degree of variability, real estate investments possess many

risks that, while not entirely unique, are not readily comparable to

typical equity investments (e.g. common stock). Real estate markets

are, for the most part, localized; investments are normally not

securitized; financial information flow is often poor; and the market

is generally not very liquid.

Real estate investment activities can increase interest rate risk;

optimum investment periods are typically long-term; real estate is

relatively lacking in liquidity; and real estate is subject to

specialized risks such as environmental liability. The experience and

expertise of management is a critical factor, and there is much

anecdotal evidence to suggest that the lack of adequate management

creates a significant level of risk of loss.

Due to the higher risk evident in real estate investments relative

to more traditional banking activities, federally-chartered banks

traditionally have been prohibited from acquiring or holding real

estate solely for investment purposes. (Real estate investment

activities remain permissible activities for subsidiaries of federally-

chartered thrift institutions.) State-chartered banks also were allowed

to engage in real estate investment activities, if permitted by state

law, without application to the FDIC until FDICIA required state-

chartered banks and their subsidiaries to obtain permission from the

FDIC to engage in activities, including real estate investment

activities, that are otherwise not permissible for national banks or

subsidiaries of national banks.

The function of an equity investor is to bear the economic risks of

the venture. Economic risk is traditionally defined as the variability

of returns on an investment. If a single investor undertakes a project

alone, all the risk is borne by the investor. If investors participate

in an investment through a vehicle such as corporate stock ownership,

that stock grants its holders pro rata participation in control of that

corporation, and in its profits and losses. If that corporation is

liquidated, the investor has a residual interest in any unencumbered

assets.

An investor typically will have a required rate of return based on

the historical track record of a particular company and/or type of

investment project. Market participants face a general trade-off: The

riskier the project, the higher the required rate of return. A key

aspect of that trade-off is the notion that a riskier project will

entail a higher probability of significant losses for the investor.

Assessments of the degree of risk will depend on factors affecting

future returns such as cyclical economic developments, technological

advances, structural market changes, and the project's sensitivity to

financial market changes.

The actual return on an investment, however, will depend on

developments beyond the investor's control. If the actual return is

higher than the expected rate, the investor benefits. If the project

falls short of expected returns, the investor suffers. At the extreme,

an

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investor can lose all or some of the original investment.

Investments in real estate ventures follow this pattern. In fact,

equity investments in commercial real estate have long been considered

fairly risky because of the uncertainties in the income stream they

generate. Both commercial and residential real estate markets in the

post- World War II period have been marked by large cyclical swings.

Two of those cyclical periods (the mid-1970s and the late 1980s through

early 1990s) involved massive overbuilding of commercial projects. That

overbuilding resulted in sharp declines in commercial property prices

and serious losses to many investors. The historical performance of the

industry clearly demonstrates considerable risk for investors.

If an investment is made solely using the funds of an investor, the

investor bears all the risk. However, if the project is partially

financed by debt, the risks are shared with the lender. Nonetheless,

the equity investor typically still bears the bulk of the variation in

the risk and rewards of an investment. As a rule, the lender is

compensated at an agreed amount (or formula in the case of a variable

rate loan). The lender is paid--both interest and principal--before the

equity investor/borrower receives any rewards or return of investment.

Thus, any downside outcome is borne first by the equity investor. In

properly underwritten loan arrangements the lender bears the economic

risk of significant losses only in the case of significant negative

outcomes. Since the legal priority of the debt holder is higher in a

liquidation or bankruptcy than that of the equity holder, the debt

holders are hurt if the investment entity has very limited resources.

Of course, the borrower/equity investor receives all of the up-side

potential returns from the investment.

While a leveraged investor has less of his/her own funds at stake,

the use of borrowed funds to finance an investment greatly magnifies

the variability of the returns to the equity investor. That is to say,

leverage increases the risks involved. For instance, a small decline in

income in an unleveraged investment may only mean less positive

returns; to the leveraged investor, it may mean out of pocket losses,

as debt service may have already absorbed any income generated by the

project. Conversely, a small increase in generated income may just

moderately increase the rate of return on an all equity investment but

have a major positive effect on the highly leveraged investor.

The fact that most commercial real estate investments are highly

leveraged also affects overall market volatility. For instance, high

interest rates will lower the expected rate of return for highly

leveraged investments which will, in turn, lower effective demand.

Thus, prices offered for commercial real estate during periods of high

interest rates typically are lowered. For example, to the extent that

there was a ``credit crunch'' for commercial real estate in the early

1990s and lenders were unwilling to extend credit, diminished effective

demand for a property could have resulted in the elimination of a broad

class of potential investors, rather than simply a lower price being

bid.

The economic viability of any investment in real estate ultimately

depends on the economic demand for the services it provides. Thus,

fluctuations in the economy in general are translated into

uncertainties in the underlying economics of most real estate

investments. National economic trends, regional developments, and even

local economic developments will affect the volatility of returns. A

traditional problem for real estate investors in that regard is that,

when the economy as a whole reaches capacity during an economic

expansion, they are one of the sectors seriously affected by the

resulting run-up in interest rates.

Much of the uncertainty associated with real estate investment,

however, comes from the nature of the production itself--how new supply

is brought to market. Investments in the construction of real estate

typically have a long gestation period; this long planning period is

especially characteristic of large commercial development projects.

Given the traditional cyclicality of the economy and financial markets,

the economic prospects for an investment can change radically during

that period, altering timing and terms of transactions.

Moreover, real estate investors also typically have trouble getting

full information on current market conditions. Unlike highly organized

markets where participants can easily obtain data on market

developments such as price and supply considerations, information in

the commercial real estate market is often difficult, or impossible, to

obtain. Also inherent in the investment process for commercial real

estate is the fact that the market is relatively illiquid--particularly

for very large projects. Thus, instead of having numerous frequent

transactions that incorporate the latest market information and ensure

that prices reflect true economic value, markets can be thin and the

timing of a sale or rental contract can affect the value of the

underlying investments.

In addition to the inherent illiquidity of commercial real estate

markets, transactions often are ``private deals'' in which the major

parameters of the investment are not available to the public in general

and, in particular, to rival developers. For instance, the costs of

construction are a private transaction between the developer and his

contractor. Likewise, gauging selling prices or rental income is

difficult since: (1) There are no statistical data on transaction

prices available as there are for single-family structures and (2) even

if there were data available, it would be impossible to account for the

many creative financing techniques involved in commercial sales and in

rental agreements (e.g., tenant improvements and rent discounting).

Because of imperfect market information and the length of the

production process, prices of existing structures are often

artificially bid up in market upswings. That is, short-term shortages

fuel speculative price increases. Speculative price increases (whether

it be for raw land, developed construction sites, or completed

buildings) typically encourage even more construction to take place,

leading to additional future overbuilding relative to underlying

demand.

In addition to the inherent cyclicality of real estate markets,

several underlying factors create additional uncertainties in the

investment process. Changes in tax laws will affect the profitability

of real estate investments. For example, tax changes were a major

consideration in the 1980s, but changes in depreciation allowances and

in tax rates have been commonplace in the post-World War II era.

Another uncertainty is the effect of other governmental actions,

especially in the area of regulations. A prime example is Federal

mandates requiring clean-up of existing environmental hazards that

imposed unexpected costs on investors at the time they were passed.

Similar uncertainties result from state and local laws that effect real

estate and how it can be developed. For instance, changes in

environmental restrictions of new construction can add unexpected costs

to a project or even bar its intended use. Similarly, a zoning change

can positively or negatively affect investment prospects unexpectedly.

All of these factors add to the uncertainty of returns and thereby

increase the risk of the investment.

Two other considerations often play into increasing risks in real

estate investment. First, the efficient execution of a real estate

investment usually

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requires a ``hands on'' approach by an experienced manager. This level

of involvement is especially true of a construction project where

developers have to deal with a wide variety of problems ranging from

governmental approvals to sub-contractors and changing commodity

markets. For an investment in developed real estate, maintenance

problems, replacing lost tenants, and adjusting rents to retain tenants

all must be addressed in an environment of ever changing market

conditions.

Many equity investors solve these problems by ``hiring'' someone

else to manage the investment. The experience of the 1980s shows that

there are specific risks involved in separating ownership from

management. For instance, many tax-oriented investors in the early

1980s arguably knew little about the basic economics of the investments

they were undertaking. In a perfect world, ``passive'' investment would

work just as efficiently as direct, active investment. In reality,

investment outcomes are likely to be more uncertain for equity

investors when someone else is making decisions that affect the

ultimate return.

Finally, an issue that plays into long-run risks in real estate

investment is the fact that real estate markets--especially commercial

real estate markets--are affected by both national and local

developments. Even if knowledge were more widespread within local real

estate markets, it is difficult to track all the relevant parameters of

the investment decision geographically. Most commercial real estate

investments have both a local and national component because firms

demanding commercial floor space are typically geographically mobile.

For example, the developer of an industrial park would have to be

concerned about how existing and future developments located in close

proximity to the project might affect the returns on the investment.

However, operating income and the ability to attract and keep tenants

also can be affected by market conditions around the country.

A financial institution--like any other investor--faces substantial

risks when it takes an equity position in a real estate venture. If the

investment were a direct, all-equity venture, the institution would

bear all of the substantial economic risks in this highly-cyclical

industry. If the entity making the investment is highly leveraged, a

completely new set of financial risks are incurred. A poor investment

outcome can quickly wipe out the leveraged equity investment. Finally,

the risks also can easily be magnified if--because of the form of

investment or debt instrument--the equity investor is separated from

the day-to-day economic and financial decisions affecting the prospects

for the venture.

Conditions Imposed in Connection With Approvals of Real Estate

Applications

In view of the risks identified with real estate investment

activities, the statutory requirement that approval should not be

granted unless the FDIC determines that the activity does not pose a

significant risk to the fund, and the FDIC's loss experience relating

to institutions that failed either partly or principally because of

real estate investment activity, staff determined that a number of

prudential constraints may be necessary to control the risk to the

individual bank and to the deposit insurance fund before concluding

that real estate investment activities do not present a significant

risk to the fund.

To date the FDIC has evaluated a number of factors when acting on

applications for consent to engage in real estate investment

activities. Where appropriate, the FDIC has fashioned conditions

designed to address potential risks that have been identified in the

context of a given application. In evaluating an equity real estate

investment activity application the FDIC has usually considered the

type of proposed real estate investment activity to determine if the

activity is unsuitable for an insured depository institution. The FDIC

also has reviewed the proposed subsidiary structure and its management

policies and practices to determine if a bank is adequately protected

from litigation risk and analyzed capital adequacy to ensure that a

bank first devotes sufficient capital to its more traditional banking

activities. In conjunction with this evaluation, the FDIC has evaluated

capital adequacy with respect to a bank's ``consolidated'' and ``bank

only'' leverage and risk-based capital ratios. In doing so, the FDIC

excluded all investments in real estate investment subsidiaries from

capital in the ``bank only'' capital calculation. The FDIC has

evaluated limitations on investment in a subsidiary engaging in real

estate investment activities to assure that the maximum risk exposure

is nominal; evaluated policies relating to extensions of credit to

third parties for subsidiary-related transactions to determine if they

protect the bank from concentrations of risk; and reviewed policies on

engaging in transactions in which insiders are involved to determine if

they protect the bank from potential insider abuse. In addition, the

FDIC has reviewed policies relating to the conditioning of loans on the

purchase of real estate from the subsidiary and the extending of credit

by the bank to third parties for the purpose of acquiring real estate

from its subsidiary to determine if they prevent undesirable tying

relationships and to determine if they are adequate to ensure that

sound credit underwriting is maintained. Finally, the FDIC has reviewed

and evaluated management's particular expertise relative to the

activities in question.

In every instance in which the FDIC has approved an application to

conduct a real estate investment activity a number of conditions have

been imposed for prudential reasons due to the unpredictability of

returns and other risks which are inherent in real estate investment

activities as well as to mitigate potential insider conflicts of

interest and to reduce risk to the insurance fund. In short, the FDIC

has determined on a case-by-case basis that the conduct of certain real

estate investment activities by a majority-owned subsidiary of an

insured state bank will not present a significant risk to the deposit

insurance fund provided certain conditions are observed. The conditions

which have been imposed as well as the purpose intended to be achieved

by imposing the conditions are discussed below. Not every condition has

been imposed in connection with each approval. The conditions have been

imposed on a case-by-case basis in light of the particular facts.

Capital

Most of the approval orders have a condition concerning capital.

Often the statutory requirement to meet and maintain adequate capital

is restated. In some instances, banks applying to conduct real estate

investment activities that entail more inherent risk, such as

undertaking a development project, have been required to maintain

capital that equals or exceeds the level required for ``well

capitalized'' institutions as defined in Part 325 after deducting the

bank's investment in any subsidiaries engaged in real estate investment

activities. The capital deduction has not been imposed in most

approvals of applications when the bank is liquidating existing real

estate investments. Indirect real estate investment activities for

purposes of the orders typically has been defined to include equity

interests in the real estate subsidiary, debt obligations of the

subsidiary held by the bank, bank guarantees of debt obligations issued

by the subsidiary, and extensions of credit or commitments of credit to

any third party for the purpose of making a direct investment in the

subsidiary or making

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an investment in any investment in which the subsidiary has an

interest. The purpose of requiring the bank to be well-capitalized on a

bank-only basis is to ensure the continued viability of the bank, if

the investment in the subsidiary were to be lost. Such a calculation

serves as an ``acid test'' of the worst-case impact a real estate

investment activity would have on an institution's capital position in

the event that an institution's entire real estate-related investment

were to be dissipated.

In instances in which the capital deduction has been imposed the

bank has been required to take the deduction for call report purposes

including for purposes of prompt corrective action and risk based

premiums, except that the deduction is not taken when determining

whether the bank is critically under-capitalized.

Transactions with Affiliates

Another condition that FDIC frequently has imposed requires that

transactions between a bank and its real estate subsidiary comply with

the restrictions that would apply under sections 23A and 23B of the

Federal Reserve Act (12 U.S.C. 371c and 371c-1) as between a bank and

its affiliate. Among other things, section 23A requires that a bank

limit its covered transactions with affiliates to no more than 10% of

the bank's capital for one affiliate and 20% of its capital for all

affiliates. For the purposes of 23A, capital and surplus is defined as

Tier 1 and Tier 2 capital included in an institution's risk-based

capital under the capital guidelines of the appropriate Federal banking

agency, based on the institution's most recent consolidated Report of

Condition and Income filed under 12 U.S.C. 1817(a)(3) and the balance

of an institution's allowance for loan and lease losses not included in

its Tier 2 capital for purposes of the calculation of risk-based

capital by the appropriate Federal banking agency. The effect of the

section 23A restrictions is to also prohibit the bank and its

subsidiary from purchasing low-quality assets from each other unless a

commitment was made to purchase the asset before its acquisition by the

affiliate, pursuant to an independent credit evaluation.

Section 23B generally requires that covered transactions between a

bank and its affiliate (including the purchase of services or assets

from an affiliate under contract) are entered into under terms that are

substantially the same, or at least as favorable to the bank as those

prevailing at the time for comparable transactions with or involving

other nonaffiliated companies. Section 23B also generally requires that

affiliates not purchase as fiduciary any securities or other assets

from any affiliate unless such purchase is permitted under the

instrument creating the fiduciary relationship, by court order or by

law. In addition, section 23B prohibits affiliates from publishing any

advertisement or entering into any agreement stating or suggesting that

the bank is in any way responsible for the obligations of its

affiliates.

FDIC has imposed the above restrictions to keep the transactions

between the bank and the real estate investment subsidiary at arm's

length and to limit the bank's investment in the subsidiary. In

instances in which an application has involved continuing investment in

a subsidiary that at the time of application exceeds these limits, the

FDIC has usually modified the limitation to allow the excess investment

while imposing the amount limits on future transactions. The FDIC often

has made an exception for the collateral and amount limitations imposed

on loans from the bank to facilitate the sale of the real estate

investments held by the subsidiary, provided that the loans are

consistent with safe and sound banking practices, do not present more

than the normal degree of risk of repayment, and the credit is extended

on terms and under circumstances, including credit standards, that are

substantially the same, or at least as favorable to the bank as those

prevailing at the time for comparable transactions.

Real Estate Subsidiary Structure and Operations

There are numerous benefits which flow from ensuring that a parent

and its subsidiary maintain a separate corporate existence. Such

separation insulates banks and the deposit insurance fund from undue

risk and potential liability stemming from litigation. To protect

against ``piercing the corporate veil'' between the subsidiary and

parent, thus mitigating litigation risks, the FDIC usually has required

that the bank conduct real estate investment activities in a majority-

owned subsidiary which is adequately capitalized; is physically

separate and distinct in its operations from the operations of the

bank; maintains separate accounting and other corporate records;

observes corporate formalities such as holding separate board of

directors' meetings; maintains a board of directors with one or more

independent, knowledgeable outside directors and management expertise

capable of conducting activities in a safe and sound manner; contracts

with the bank for any service on terms and conditions comparable to

those available to or from independent entities; and conducts business

pursuant to separate policies and procedures designed to inform

customers and prospective customers of the subsidiary that it is a

separate organization from the bank, including the placement of

specific language on any debt instrument or contract with a third party

disclosing that the bank itself is not responsible for payment or

performance. The FDIC has recognized that requiring total separation of

the management of the subsidiary from the bank's management could

enhance the corporate separateness of the subsidiary. However, in

keeping with the FDIC's review and analysis of the downside risks real

estate investments pose when separating ownership from management, the

Board typically has required only a minimum of one independent

director. In addition, FDIC has considered the presence of one or more

outside directors to be a helpful deterrent to potential insider abuse,

an enhancement to diversity and expertise and an opportunity to augment

decision-making with a counterbalancing perspective.

Investment Limits

In order to maintain proper diversification and to effectively

control the concentration of credit and investment risk, FDIC has

required banks to identify and aggregate loans made to third parties

for the purpose of investment in real estate held by the bank's

subsidiary with the bank's own real estate investment activities and

included that figure in the bank's investment in the real estate

subsidiary. Generally, the FDIC has limited the amount of real estate

investment activity to the amount contemplated in the business plan

submitted with the application and requires the bank to notify the FDIC

in the event of any significant change in facts or circumstances. This

condition is designed to limit the exposure from the real estate

investment activity and allow the FDIC to evaluate any additional real

estate investment activity when contemplated by the bank.

Lending to Third Parties

The FDIC has conditioned approvals of applications to conduct real

estate investment activity by including limits on the extension of

credit to third parties for a direct investment in a bank subsidiary

engaged in real estate investment activity to further limit the

exposure of the state bank to real estate investment.

[[Page 43492]]

Insiders

Limiting buying and selling by bank insiders also has been imposed

as a condition to the approval of applications to conduct real estate

investment activity. These conditions generally require that the bank's

subsidiary not be permitted to engage directly or indirectly with

insiders in transactions involving the subsidiary's real estate

investment activities without the prior written consent of the FDIC.

These restrictions are in addition to the constraints on lending to

insiders imposed by Regulation O (12 CFR 337.3). The bank is expected

to identify conflicts of interest and their resolution by the Board

should be documented.

Fiduciary and Trust Restrictions

In order to maintain safe and sound underwriting standards, to

reduce or preclude the potential for breaches of fiduciary duties, and

to protect the bank and the deposit insurance fund, FDIC has imposed

one or more of the following conditions: (1) That the bank not

condition any loan on the purchase or rental of real estate from any

subsidiary engaged in real estate investment activities; and (2) that

the bank not purchase real estate from the subsidiary in its capacity

as a trustee for any trust, unless expressly authorized by the trust

instrument, court order, or state law.

On occasion, FDIC has imposed a condition that any potential

conflict of interest be identified, appropriately resolved, if

possible, and approved by the bank's board of directors prior to the

consummation of any transaction. This condition is considered a

reasonable approach to avoiding the risk of loss from conflicts of

interest while providing the bank with flexibility in resolving any

such issue.

Life Insurance Investments

The Office of the Comptroller of the Currency (OCC) has established

certain general guidelines for national banks to use in determining

whether they may legally purchase a particular insurance product. These

guidelines are contained in an OCC Banking Circular (BC 249), issued

May 9, 1991. That circular indicates that the authority for national

banks to purchase and hold an interest in life insurance is found in 12

U.S.C. section 24 (seventh) which permits national banks to exercise

all such incidental powers as shall be necessary to carry on the

business of banking.1 The circular indicates that the OCC has

further delineated the scope of that authority through regulations,

interpretive rulings, and letters addressing the use of life insurance

for purposes incidental to banking. Although the circular leaves open

the possibility that there may be other uses of life insurance that are

``incidental to banking'' (the circular says the purposes ``include''

those described in the circular), the circular clearly indicates that

there is no authority under 12 U.S.C. 24 (seventh) for national banks

to purchase life insurance for their own account as an investment. If

an insured state bank wishes to purchase an insurance product that does

not meet the guidelines contained in BC 249, that purchase is

considered to be an activity that is not permissible for a national

bank within the meaning of part 362. The purchase by the state bank

would therefore not be permissible unless the bank meets its minimum

capital requirements and the FDIC determines that there is no

significant risk to the deposit insurance funds. Under current

regulations the bank must make application for consent to make or

retain the investment and the FDIC then makes a determination based on

the facts and circumstances of the particular case.

---------------------------------------------------------------------------

\1\ In one instance the circular cites to 12 U.S.C. section 24

(fifth) which authorizes national banks to elect or appoint

directors and to employ bank officials.

---------------------------------------------------------------------------

The BC 249 provides two tests for national banks to use in

determining whether they may legally purchase a particular insurance

product. Test A relates to key-person life insurance. Under Test A the

insurance coverage must closely approximate the risk of loss. Test B

relates to life insurance as an employee benefit and provides that,

based upon reasonable actuarial benefit and financial assumptions, the

present value of the projected cash flow from the policy (insurance

proceeds) must not substantially exceed the present value of the

projected cost of the associated compensation or benefit program

(employee benefits). Insurance as an estate planning benefit is

specifically recognized, but only as part of a reasonable compensation

agreement or benefit plan.

Insurance proceeds include projected death benefits, loans against

the policy before the death of the insured to fund retirement payments,

and any other withdrawals by the bank. The projected cost of employee

benefits includes the bank's actual cost associated with the insurance

policy (the periodic mortality charges, loads, surrender charges,

administrative charges and other fees that are expected to be assessed

against the policy's cash surrender value during the term of the

policy) plus the projected amount of any retirement or other deferred

benefit payments that are expected to be paid out to employees or their

beneficiaries.

It is well established that certain types of insurance products are

actually ``securities'' under the Federal securities laws. Certain life

insurance policies--common names include universal life or variable

life--are ``securities.'' Banks may have to hold these investments

through a subsidiary, rather than directly. If the life insurance

policy in question is considered to be a security, and it does not

qualify under either Test A or Test B of OCC BC 249, then the life

insurance policy must be held through a subsidiary of the bank as

required under section 24 and part 362.

Risks Associated With Life Insurance Investments

A bank holding a life insurance contract as an investment is

exposed to a variety of risks, most of which are similar in nature to

the types of risks banks are exposed to on both sides of the balance

sheet: credit risks, liquidity risks, and interest rate risks. In

addition, there is actuarial risk inherent in holding a life insurance

policy that exposes banks to different risks than are usual in the

banking industry. Unless the issuing company becomes insolvent, a life

insurance policy investment gives a bank the potential for low returns

over the life of the investment, rather than loss of principal.

Banks purchase various forms of life insurance contracts as either

key-person protection for the bank or as a compensation benefit for the

employee. In certain instances, the policies provide a benefit to

executive officers who are also majority stockholders in the form of an

estate planning tool. Many of these policies require large single

premiums or periodic premiums of a substantial amount. These premiums

may result in the build-up of significant cash surrender or investment

values that cannot be easily liquidated without adverse tax

consequences.

Since life insurance products represent an unsecured obligation of

the issuing company, there is some credit risk involved in these

products. As the companies are regulated by state insurance

commissioners without any federal regulatory oversight, there will be

some variation in the strictness of the regulatory regimes from state

to state. If a state insurance commissioner declares a firm to be

insolvent, the holders may receive payments from (1) other insurance

companies (the industry has, in some past events, supported the

policies of failed firms in order to promote investor confidence.); (2)

liquidation of the issuer's assets and sale of the firm; (3) lawsuits;

and/or (4)

[[Page 43493]]

state insurance funds. The existence, structure, and coverage provided

by these funds varies, however, they typically are not pre-funded and

may ultimately be unable to provide the required support.

Unlike other types of investments, no secondary market for

insurance products exists, making some liquidity risk inherent in these

investments. Cashing out the policy can be costly because of the tax

consequences. The illiquidity of the policies may be mitigated by two

factors: (1) Many policies have provisions that permit the holder of

the policy to borrow against the current cash value at a minimal

interest rate, and (2) a bank moving toward insolvency holding an

insurance policy will probably be able to offset other losses with the

taxable income that is realized by cashing out the policy.

The interest rate risks inherent in an insurance policy will vary

with each insurance contract. The build-up of cash value depends on the

performance of the underlying investment portfolio. Individual

portfolios often have different interest rate risk characteristics.

Insurance companies may write whole life policies with a single

interest rate applied to the cash buildup, making the interest rate

risk very high. Other policies may give the insurance company

flexibility in determining the applicable future interest rates. These

policies present actuarial risks because the maturity date of an

insurance policy held until the death benefit is paid is unknown at the

time the investor purchases the policy. Prior to the death of the

insured party, comparing the investment returns provided by such a

policy with alternative investments requires the calculation of an

actuarial estimate of the life expectancy of the insured party. Should

the insured die prior to his/her estimated life expectancy, the

beneficiary reaps an investment windfall. However, if the insured's

life exceeds the actuarially determined life expectancy, the ultimate

performance of the investment will suffer (relative to the returns that

would have been realized from alternative investments undertaken at the

time). Insurance companies control the variance of results by applying

actuarial principles to large populations of insured individuals. A

bank holding policies on a handful of former employees cannot control

the variability of the returns.

Various supervisory concerns can arise when banks invest in

insurance policies. These concerns include potential violations of laws

and regulations, a less than adequate rate of return, the illiquid

nature of the investment, the potential for substantial tax

obligations, and concentration of investment risk.

The FDIC scrutinizes bank purchases of life insurance for three

particular potential violations other than section 24. Where a bank

purchases split-dollar insurance to provide a fringe benefit to an

executive officer of a bank, the executive must either reimburse the

bank or report as additional taxable income the economic value of the

benefits (as determined by the IRS). Otherwise, a violation of Federal

Reserve Board Regulation O may occur (12 CFR part 215).

When a bank's holding company or other affiliate is a beneficiary

of a life insurance policy purchased by a bank, the holding company

must pay for its beneficial share of the premiums and periodic costs of

the policy in order to comply with sections 23A and 23B of the Federal

Reserve Act (12 U.S.C. 371c and 371c-1). If, net of such

reimbursements, the present value of projected insurance proceeds

substantially exceeds the present value of employee benefits, the

insurance arrangement will fail to meet the BC 249 standards.

For those insurance arrangements that will provide compensation or

other benefits to employees or their beneficiaries, the amount of such

expected benefits must be quantified and not exceed reasonable

compensation levels when combined with other forms of compensation

provided to those employees. Section 39 of the FDI Act prohibits

excessive compensation as an unsafe or unsound act.2

---------------------------------------------------------------------------

2 12 U.S.C. 1831p-1(c).

---------------------------------------------------------------------------

The propriety of investing large sums in a policy that, over time,

may provide a less than adequate rate of return is a consideration.

However, these assets should be viewed in the context of the bank's

overall asset and liability structure and not viewed in isolation to

determine if they pose a significant risk to the fund.

Supervisory concern may exist over the long-term, illiquid nature

of those insurance policies that cannot realistically be liquidated at

the option of the bank without incurring sizeable surrender charges and

adverse tax consequences. Liquidity should not be judged in isolation

from other assets of the bank. Liquidity concerns may be mitigated if

the bank has the ability to borrow against the policies without

incurring adverse tax consequences or surrender charges.

Banks generally do not pay federal income taxes on the increases in

the cash value of an insurance policy as long as the bank holds the

policy until the death of the insured. As a result, banks that intend

to hold the policy until the insured's death normally do not record any

deferred tax liability for accounting purposes. However, should the

bank surrender the policy prior to the insured's death, the bank would

incur taxable income if the cash value received exceeded the amount of

premium paid. The cash value build-up over time could result in sizable

income taxes should the policy be surrendered early.

Due to the liquidity, credit, and tax considerations, unduly large

concentrations in investments in life insurance policies could result

if a bank does not adopt prudent constraints on the amount of its

exposures.

Life Insurance Applications

As of June 4, 1996, the FDIC had acted upon 106 applications by

insured state banks for consent to continue to hold investments in life

insurance policies. 101 of these applications involved policies

acquired prior the effective date of the activities restrictions of

section 24 of the FDI Act (December 19, 1992). Four banks had policies

that were acquired after December 19, 1992, and one bank had a

combination of policies acquired before and after the effective date.

Of the 106 applications, almost two thirds (67) of the institutions

were operating with a UFIRS composite rating of 2. Thirty (30)

applications were from institutions that had composite ratings of 1,

seven with a rating of 3, and two had a UFIRS composite rating of 4.

None were 5 rated.

The insurance policies held by any one bank ranged from less than

1.0% of Tier 1 capital to 52% of Tier 1 capital. Over ninety percent

(88 of 106) of the banks held investments totaling less than 30% of

Tier 1 capital. However, 63 of the 106 applications involved an

aggregate investment that did not exceed 20% of Tier 1 capital with the

majority (45 of 63) of those investments representing less than 10% of

Tier 1 capital.

All of the applications were approved. The actions were taken

either by the FDIC Board of Directors or by the Director of the

Division of Supervision pursuant to delegated authority.

The FDIC required all of the banks receiving approval to adhere to

specific conditions deemed necessary to limit the risk to the banks and

thus the insurance fund. Among the conditions were: (1) that the bank

continue to meet applicable capital standards, (2) that the

[[Page 43494]]

bank shall notify the FDIC of any significant changes in the facts or

circumstances on which the approval was based, (3) that the bank may

not modify the terms or conditions of the policies (except for

redemption of same) without the prior written consent of the FDIC, (4)

that the bank may not acquire any additional life insurance policies

without prior written consent of the FDIC, (5) that the bank must

reduce the cash surrender value of the policies, (6) that the bank must

receive approval of its applicable state authority, (7) that the bank

may not pay additional annual premiums without consent of the FDIC, and

(8) that the timing and amounts of the holding company's proportionate

share of overall insurance costs will be made in a manner which will

preclude any violations of section 23A or 23B of the Federal Reserve

Act. Some or all of these conditions were imposed where the facts

warranted the imposition of the particular condition in order to

protect the deposit insurance fund from risk.

Annuity Contracts

Interpretative guidance issued by the OCC states that national

banks are not permitted to invest in annuities for their own account.

If an insured state bank wishes to purchase an annuity contract, the

purchase is considered an activity that is not permissible for a

national bank and section 24 of the FDI Act applies. The purchase by

the state bank would therefore not be permissible unless the bank meets

it minimum capital requirements and the FDIC determines that there is

no significant risk to the deposit insurance funds.

As noted above, certain types of life insurance policies and

annuity contracts are considered to be ``securities'' under the federal

securities laws. If the annuity contract in question is considered to

be a security, and this would apply to variable rate annuity contracts,

it must be held through a subsidiary of the bank as required under

section 24 and part 362. Fixed rate annuity contracts are considered to

be insurance products and may be held directly by the bank.

A bank holding annuity contracts in connection with a deferred

compensation plan is exposed to a variety of risks, most of which are

similar in nature to the types of risks banks are exposed when

investing in life insurance policies: credit risks, liquidity risks,

and interest rate risks.

Annuity contracts are similar to certificates of deposit in that

the investor places money with an institution, such as an insurance

company, in the expectation of the return of the investment plus

earnings at a specified later date or on a specified schedule. Some

annuities provide that the investor may select a lifetime payout, which

provides a fixed income until the death of the annuitant. However,

unlike a bank certificate of deposit, an annuity is uninsured, creating

credit risk. An investor is not subject to the risk of loss of

principal through market fluctuations, but the investor has credit risk

based on the solvency of the issuing entity.

The lack of a secondary market for annuities gives rise to

liquidity risk. Such investments are generally long term, subject to

varying early withdrawal penalties and early redemption may cause a

loss of tax deferral advantages.

Interest rate risk arises from fixed rate annuities, particularly

in light of the long term nature of these contracts. Most insurance

companies offer variable rate arrangements to mitigate interest rate

risk. However, the issuing company generally determines interest rates

on variable rate contracts and may not use a common index. For this

reason, future yields are uncertain and likely to be lower than other

available types of investments. However, interest rate floors may

mitigate this risk. We see the same interest rate structure in certain

types of life insurance policies wherein the return is dependent on an

interest payment calculated on the cash surrender value of the policy.

Various supervisory concerns similar to those associated with

investments in insurance policies arise when banks invest in annuity

contracts. They include potential violations of laws and regulations,

less than adequate rate of return, the illiquidity of the investments,

and concentration of investment risks. For those annuities that will

provide compensation or other benefits to employees or their

beneficiaries, the amount of such expected benefits must be quantified

and not exceed reasonable compensation levels when combined with other

forms of compensation provided to those employees. As stated earlier,

section 39 of the FDI Act prohibits excessive compensation as an unsafe

or unsound act.3

---------------------------------------------------------------------------

\3\ 12 U.S.C. 1831p-1(c).

---------------------------------------------------------------------------

A less than adequate rate of return is also a concern such that the

propriety of investing large sums in an annuity contract or numerous

contracts is also a consideration. However, as with insurance products,

annuity contracts should be viewed in the context of the bank's overall

asset and liability structure and not viewed in isolation in order to

determine if they pose a significant risk to the fund.

Because of the illiquid nature of long-term annuity contracts,

banks often find it difficult to liquidate the contracts without

incurring sizeable surrender charges. The illiquid nature of the

assets, however, should be viewed from an overall impact on the bank in

conjunction with other assets of the bank. Liquidity concerns may also

be mitigated if banks have the ability to borrow against the contracts

without incurring adverse surrender charges or adverse tax

consequences. Due to the liquidity and credit risks, unduly large

concentrations in investments in annuity contracts could result if a

bank does not adopt prudent constraints on the amount of its exposures.

Approved Annuity Applications

As of June 4, 1996, the FDIC has acted upon 2 annuity applications.

These actions, all approvals, were taken by the Board of Directors. The

actions were contingent upon conformance to specific conditions deemed

necessary to limit the risk to the bank. Those conditions addressed

concerns the FDIC Board of Directors had relative to these products.

Description of Proposed Exceptions

As stated earlier, the FDIC is proposing to amend part 362 to

provide a notice process for certain insured state banks proposing to

invest in or retain real estate or life insurance and annuity

contracts. Currently all insured state banks wishing to indirectly

retain or acquire impermissible real estate investments, or directly or

indirectly invest in nonconforming life insurance and annuity

contracts, must apply to the FDIC for approval under section 24 of the

FDIA and part 362. As detailed above, the FDIC Board has had a

significant amount of experience with both types of applications and

has concluded that it is possible for an insured state bank to engage

in such activities without posing a significant risk to the deposit

insurance fund. The FDIC recognizes that the application process can be

costly and time consuming for insured state banks. Based on the Board's

experience and the goal of relieving regulatory burden on insured state

banks, the FDIC is proposing to amend its regulations to permit certain

highly rated banks to engage in such activities under certain

circumstances without the need for an application. The proposed

exceptions would be added to the list of activities found in

Sec. 362.4(c)(3) which the FDIC has found do not present a significant

risk to the deposit insurance fund.

[[Page 43495]]

The FDIC proposes to permit certain highly rated insured state

banks to file notices 60 days prior to making an indirect investment in

real estate or a direct or indirect investment in life insurance or

annuity contracts. The procedures for filing, review and action on both

types of notices are the same, however, there are certain conditions

which insured state banks must meet in order to be eligible for the

notice processing. The conditions in the case of real estate

investments are more numerous and detailed than the conditions in the

case of life insurance and annuity contract investments. For instance,

banks wishing to invest in real estate must use a subsidiary organized

solely for such purpose whereas banks will be permitted to directly own

life insurance and annuity contracts. The conditions for bank

eligibility are discussed below. The amount and type of information

required in the notices to be filed with the FDIC regional offices

differs significantly depending upon whether the bank is proposing to

invest in real estate or life insurance and annuities.

Notice Procedure

Notices are to be filed with, reviewed by and acted upon by the

FDIC regional offices. Complete notices will normally be acted upon

within 60 days of filing. Notices which do not include all the required

information are not considered complete. The 60 day review period

begins when all required information has been received by the FDIC

regional offices. The FDIC regional offices will issue a letter to the

insured state bank confirming receipt of the notice and advising the

insured state bank of the date after which the bank may engage in the

activity if the FDIC has not objected. The notice will be reviewed for

the purpose of determining whether the bank is in fact eligible for the

exception as well as for the purposes of determining whether particular

facts and circumstances unique to the institution raise policy or legal

concerns warranting additional action on the part of the FDIC. If

safety or soundness issues are identified which do not rise to the

level of presenting a significant risk to the deposit insurance fund,

it is contemplated that the regional office will work with the bank

during the notice period to correct the problems which have been

identified.

FDIC Action on Notices

The FDIC regional offices can issue a letter of nonobjection before

the end of the 60 day notice period advising the bank that it may

proceed with the proposed investment or activity. The FDIC regional

offices could also issue to a bank a letter of objection before the end

of the 60 day review period. A letter of objection would mean that the

FDIC regional offices have determined that either the insured state

bank does not qualify for notice processing or that the activity raises

legal or policy concerns given the particular circumstances. If the

regional offices determine that the bank does not meet the eligibility

requirements or raises legal or policy concerns, the notice can be

converted at the bank's option into an application and be processed in

accordance with other provisions of part 362.

The FDIC regional offices can extend the 60 day review period for

an additional 30 days if it provides written notice of the extension to

the insured state bank before the 60 day review period has run. The

FDIC does not anticipate that extensions will occur frequently. FDIC

regional offices should review and act on notices as quickly as

possible, with the 60 day review period generally being seen as an

outside limit.

Should the FDIC regional offices fail to take written action by the

end of the 60 day period, or the 90 day period if a 30 day extension

has been taken, the FDIC shall be deemed to have issued a letter of

nonobjection. In such event the insured state bank may engage in the

activity on the terms and conditions as described in its notice,

subject to the continued obligation to comply with the conditions set

out in the exception. It is the FDIC's intent to normally respond to

notices rather than to simply allow the notice period to expire.

Issuance of a letter of nonobjection or permission to engage in the

activity after the notice period expires does not preclude the FDIC

from taking appropriate actions to address any safety and soundness

concerns regarding the operation of a bank, any of its subsidiaries, or

a particular investment in real estate or life insurance and annuities.

If an insured state bank's financial or managerial resources suffer an

adverse change, the FDIC retains its full authority to require the bank

to take whatever steps FDIC deems appropriate.

Treatment of Outstanding FDIC Orders

As noted above, a large number of insured state banks previously

applied for and received approval from the FDIC to invest in real

estate or life insurance and annuity contracts. The terms of the FDIC

orders approving such applications will remain in effect and not be

modified by the enactment of the proposal. To the extent those orders

differ from the notice provisions in the proposed regulation, insured

state banks may apply to the appropriate FDIC regional office for

relief (provided the bank meets the eligibility requirements) by

submitting a notice as required by the regulation and attaching a copy

of the FDIC order which they are seeking to have rescinded. The terms

of the FDIC order would remain in effect pending completion of the

notice process.

Pending Applications

If the proposal is adopted, insured state banks which have pending

real estate or life insurance and annuity investment applications and

which meet the conditions of eligibility in the proposed regulation may

``convert'' their applications to notices by submitting a letter to the

appropriate FDIC regional office requesting such treatment. The letter

requesting such treatment should show that the bank meets the

conditions of eligibility and contain such additional information as

may be necessary to complete the notice. The FDIC regional office will

either issue a letter to the insured state bank which states that the

application has been converted to a notice and advising the insured

state bank of the date after which the bank may engage in the activity

if the FDIC has not objected or issue a letter to the insured state

bank stating that the FDIC objects to the conversion request. In the

event of FDIC objection to the conversion request, the application will

continue to be processed in accordance with the other provisions of

part 362.

Continued Compliance with Eligibility Conditions

Banks which utilize the notice process to invest in real estate or

life insurance and annuity contracts must continue to meet the

conditions for eligibility set forth in the proposed regulation. Banks

which fall out of compliance with any one of the eligibility conditions

in the regulation are required to notify the FDIC regional office

within 10 business days. The FDIC regional office shall review the

notice and take such action as it deems necessary based on safety and

soundness concerns. The FDIC regional offices have a broad range of

authority with respect to the actions they can require the insured

state bank to take. For example, the FDIC regional office may require

the insured state bank to return to compliance within a specified

period of time, to submit an application pursuant to Sec. 362.4(d), to

submit a capital restoration plan, or in appropriate cases to divest

the investment.

[[Page 43496]]

Notice--Real Estate Investments

Section 362.4(c)(3)(vi)(A)--Conditions for Bank Eligibility

The notice process is available only to those insured banks which

propose to hold their real estate investments through a majority-owned

subsidiary. Structure is important with respect to real estate

investments. As noted above, the holding of real estate investments

through a subsidiary will provide some liability protection to the

bank, and ultimately the deposit insurance fund, should there be any

adverse litigation or hazardous environmental waste problems. In

addition, the subsidiary must be ``solely'' for the purpose of real

estate investments. Sole purpose subsidiaries will simplify reporting

and monitoring of the real estate investments. Insured state banks

which would like to operate mixed use subsidiaries for real estate

investments will be required to go through the normal part 362

application process.

There are nine conditions for banks that want to invest in real

estate using the notice process. The bank must have either a 1 or 2

UFIRS composite rating as assigned by the FDIC as of the most recent

rating period. The FDIC believes that only those banks which have

composite ratings of 1 or 2 are appropriate for the notice process.

These institutions have shown that they have the requisite financial

and managerial resources to run a financial institution without

presenting a significant risk to the deposit insurance fund. While

other lower rated financial institutions may have the requisite

financial and managerial resources and skills to undertake real estate

investments, the FDIC believes that those institutions should be

subject to the formal part 362 application process as opposed to the

streamlined notice process described herein.

The bank must be ``well capitalized'' as defined in part 325 of

this title after deducting the proposed real estate investment from

capital calculations. This eligibility condition reflects the FDIC's

belief that only those insured state banks with strong capital

positions should be investing in real estate. Bank capital is designed

to act as a cushion in the event of losses. As noted above, the

variability of returns on real estate investments is very wide. Banks

can not count on any return on their real estate investments, and may

in fact end up losing the entire investment. For this reason, the FDIC

believes the capital deduction reflects a more accurate assessment of

the bank's capital position.

As noted above, to be eligible for notice processing a bank must

use a subsidiary for the real estate investment. The real estate

subsidiary must meet several conditions. First, the subsidiary must

meet the definition of ``bona fide subsidiary'' as contained in

Sec. 362.2(d), except a majority of the subsidiary's officers and

directors may be directors or executive officers of the bank. However,

the subsidiary must have at least one director who is knowledgeable

with respect to real estate investment activities and is not an

employee, officer or director of the bank. This requirement is to

assure that the real estate subsidiary is in fact a separate and

distinct entity. As discussed above, this requirement should insulate

the bank and the deposit insurance fund from liabilities in excess of

the bank's investment.

The FDIC believes that banks that want to engage in real estate

investment should have subsidiaries with board members that will manage

using proven experience in real estate as such experience will greatly

increase the likelihood of successful investment. The independent board

member must be an individual who is not an employee, officer or

director of the bank and who is knowledgeable with respect to real

estate investment activities. An independent director should bring

valuable experience to the subsidiary's operations. Officers, directors

or employees of the bank's holding company or of an affiliate of the

bank are eligible to fill the independent director requirement.

The bank must have a written business plan for the real estate

investment which is acceptable to the FDIC. Banks that want to engage

in real estate investment should have a written business plan which is

detailed and well thought out. Such a plan is yet another indicator

that the financial institution has adequate managerial resources to

engage in the proposed activity.

All transactions between the bank and the subsidiary should conform

to the restrictions that would apply under sections 23A and 23B of the

Federal Reserve Act as between a bank and its affiliate. This

requirement is intended to make sure that adequate safeguards are in

place for the dealings between the bank and its subsidiary. The FDIC

invites comment on whether all the provisions of sections 23A should be

imposed or whether just certain restrictions are necessary. For

instance, should the regulation simply provide that the bank's

investment in the real estate subsidiary is limited to 10% of capital

and that there is an aggregate investment limit of 20% for all

subsidiaries rather than in effect subject transactions between the

bank and its real estate investment subsidiary to all of the

restrictions of section 23A of the Federal Reserve Act. If the FDIC

were to do so, it would be the Agency's intent to monitor transactions

between the bank and its subsidiary as part of the FDIC's regulatory

oversight of the bank and to address any concerns on a case-by-case

basis.

Finally, two restrictions are imposed which are designed to address

tying and insider abuse. First, with respect to tying, neither the bank

nor the subsidiary may engage in any transaction which requires a

customer of either to buy any product or use any service of either as a

condition of entering into the transaction. This restriction on tying

transactions is broader than the conditions in previous FDIC Board

Orders in that it would cover any product or service which either the

bank or the subsidiary offers. The FDIC requests comment on whether the

tying restriction is broader than necessary. Commenters who believe the

tying restriction should be limited to loans by the bank to customers

of the real estate subsidiary should explain why these loans are the

only problematic transactions.

The second restriction is neither the bank nor the subsidiary may

engage in any transaction with a bank insider (or a related interest)

which involves the real estate investment activities of the subsidiary

unless the FDIC regional office approves the transaction in advance.

This restriction does not apply, however, to extensions of credit which

are subject to Sec. 337.3 of this title. This exception carves out

those extensions of credit by a bank to its executive officers,

directors and principal shareholders, and their related interests,

which comply with Regulation O. 12 CFR 215, subpart A.

Section 362.4(c)(3)(vi)(B)--Contents of Notice

Insured state banks which meet the conditions for eligibility would

be required to file a notice with the appropriate FDIC regional office.

The amount of information required in the real estate investments is

greater than that required in the case of life insurance and annuity

investments. The regulation sets forth seven (7) specific information

requirements, which are:

(B)(1). A brief description of the real estate investment

activities. The notice should describe the proposed investment, e.g.,

purchase of raw land, interest in a shopping center or construction of

a small office building,

[[Page 43497]]

and identify where the real estate is located.

(B)(2). A copy of the real estate investment business plan. This

written document should discuss all aspects of the proposed business,

capitalization, cash flows, expenses, market variables, etc. Banks

without written business plans will not be permitted to file notices.

(B)(3). A description of the subsidiary's operations including

management's expertise. The FDIC believes that experienced real estate

management is very important to the success of a subsidiary engaged in

real estate activities. The notice shall contain a detailed discussion

of management's real estate experience in the particular type of real

estate investment contemplated. For instance, if the subsidiary is

going to engage in residential real estate development, the application

should discuss managements proven experience in residential real estate

development.

(B)(4). The amount of bank's aggregate investment in the subsidiary

stated as a percentage of Tier 1 Capital. The notice should state

clearly the amount of investment which a bank has in the real estate

subsidiary. This includes both direct (such as contributions of capital

and loans to the subsidiary) and indirect investments (such as

extensions of credit or commitments of credit to third parties who will

be making direct investments in the subsidiary). Further, a bank shall

also include in its calculation any extension of credit or commitment

of credit to a third party which will be making an investment in any

investment which the subsidiary has an interest. Banks should not

include in their calculation of investment any retained earnings or the

value of any assets which the subsidiary may hold. Notices should

quantify and separately identify the direct and indirect real estate

investments.

(B)(5). Bank's capital after deducting the investment in real

estate. The notice should state clearly what the bank's capital

position is after deducting the investment in real estate. The bank

should set forth its 3 capital categories as of the latest call report

in both dollars and percentages. The notice should also show on a pro

forma basis what the bank's Tier 1 Capital will be, on both a dollar

and percentage basis, after making the required deduction. Stating this

information clearly in the notice will assist the FDIC regional office

in reviewing and acting upon the bank's notice.

(B)(6). A copy of the board of director's resolution authorizing

the filing of the notice. The notice should state the bank's board of

directors has authorized the proposed investment in real estate,

including the formation of a majority-owned subsidiary solely for the

purpose of investing in real estate, and authorized the filing of the

notice with the FDIC. A copy of the Board resolution(s) should be

attached to the notice.

(B)(7). The relevant state law which authorizes the bank subsidiary

to conduct real estate investment activities. The notice should

identify the relevant state statute, regulation or guideline which

permits the bank's subsidiary to invest in real estate. If an

application or some other type of approval from the state banking

regulator is required, the state banking regulator's approval or

nonobjection should be referenced. A copy of such approval or

nonobjection letter should be attached to the notice. The FDIC can not

authorize insured state banks to invest in real estate unless they are

permitted to do so under existing state law. For this reason it is

important that banks identify the relevant state statutes, regulations

or other provisions of law which permit them to engage in such

activities. Again, such information will greatly assist the FDIC

regional offices in reviewing the notices as expeditiously as possible.

Notice--Life Insurance and Annuity Products

Section 362.4(c)(3)(vii)--Condition for Bank Eligibility

The bank eligibility conditions are somewhat less restrictive for

investing in life insurance and annuity products than for real estate

investments. For instance, insured state banks wishing to invest in

life insurance and annuities are generally not required to use a

subsidiary for such investments and there is no capital ``deduction''

for life insurance and annuity investments. The less restrictive

eligibility requirements are reflective of the FDIC's view that life

insurance and annuity investments are generally less risky investments

than real estate investments.

There are six conditions for banks wishing to invest in life

insurance or annuity contracts pursuant to a notice. The bank must be

well capitalized as defined in part 325. The bank's most recent UFIRS

rating as assigned by the FDIC must be a ``3'' or better. The bank must

have in place policies and procedures for monitoring the financial

health of the companies issuing or underwriting the life insurance or

annuity contracts.

There are two percentage of Tier 1 Capital investment limits for

annuities and life insurance policies. The bank's total aggregate

investment in annuity contracts and life insurance policies which are

impermissible for national banks (nonconforming) can not exceed 30% of

the bank's tier 1 capital. The bank's total aggregate investment in all

types of annuity contracts and life insurance policies can not exceed

50% of the bank's Tier 1 capital. (A)(4). The 50% limit would include

both the national bank permissible life insurance policies as well as

those which are not permissible for national banks to hold. Banks are

also required to diversify their annuity contract and life insurance

policy risks. In order to be eligible for the notice process, a bank's

total investment in conforming and nonconforming investments from

anyone issuer cannot exceed a maximum of 15% of the bank's Tier 1

capital.

Banks are also required to purchase annuities and life insurance

policies from highly rated issuers. Under the regulation, banks are not

eligible for the notice process if they have purchased annuity

contracts or life insurance policies from issuers that are not in the

top two categories of a nationally recognized rating service. There are

several national organizations which rate insurance companies: these

organizations include A.M. Best, Standard & Poors and Moody's.

As noted above, banks are not generally required to purchase or

hold life insurance policies or annuity contracts through a subsidiary.

Some life insurance policies and annuity contracts are ``securities''

for purposes of the Federal securities laws. All annuity contracts

which are considered to be ``securities'' must be held through a

subsidiary of the bank. Those life insurance policies which do not

qualify under OCC BC 249 and which are considered to be ``securities''

must also be held through a subsidiary of the bank. Holding such

securities through a subsidiary of the bank is required pursuant

section 24 and part 362.

Section 362.4(c)(3)(vii)(B)--Contents of Notice

Insured state banks which meet the six conditions for eligibility

noted above would be required to file a notice with the appropriate

FDIC regional office. The amount of information required in the life

insurance and annuity investment notices is less than that required in

the real estate investment notices. The regulation sets forth seven (7)

specific information requirements for

[[Page 43498]]

the life insurance and annuity investment notices. They are:

(B)(1). The aggregate amount of direct and indirect investment in

life insurance policies and annuity contracts stated as a percentage of

the bank's Tier 1 Capital. The notice should state clearly the number

of annuity contracts and life insurance policies which the bank owns

(or intends to acquire), either directly or through a subsidiary. The

notice should also state the dollar value of the annuity contracts and

life insurance policies and what percentage of the bank's tier one

capital that represents. Banks should not include in this provision any

life insurance policies which a national bank would be permitted to own

under either Test A or Test B of OCC Banking Circular 249.

(B)(2). The aggregate amount of direct and indirect investment in

all life insurance policies and annuity contracts as a percentage of

the bank's Tier 1 capital. This item includes conforming as well as

nonconforming investments in life insurance policies. The notice should

identify those life insurance policies which conform to either Test A

or Test B of BC 249 and the value of such life insurance policies.

(B)(3). The concentration of investment by issuer. The notice shall

clearly state the aggregate amount of bank investment in annuity

contracts and life insurance policies from any one issuer. The FDIC is

concerned about concentration of risk from one issuer, therefore banks

should aggregate life insurance policies and annuity contracts issued

by the same company.

Calculations shall be stated as a percentage of the bank's tier one

capital. All life insurance policies, even those which may be

permissible for a national bank under OCC BC 249, should be included in

the calculation.

(B)(4). The rating of the issuer(s) of the policies and annuity

contracts. The notice should state the most current rating of the

issuer by the nationally recognized rating services which rate the

issuer. The issuer must be in one of the top two rating categories of

the rating service. If the issuer is not in one of the top two rating

categories, the bank is not eligible for the notice process. If the

issuer is rated by more than one of the nationally recognized rating

services and the issuer is not in the top two rating categories of all

services the FDIC may object to the notice.

(B)(5). A description of the bank's monitoring procedures. The

notice shall identify and briefly describe the bank's procedures for

monitoring the financial health of the issuer. The notice shall, at a

minimum, identify the individual or committee responsible for

monitoring the financial status of the issuer and how frequently the

monitoring is done. If the procedures are in writing, they should be

attached to the notice.

(B)(6). The relevant state law which authorizes the bank investment

in life insurance policies or annuity contracts should be identified.

The notice should identify the relevant state statute, regulation or

guideline which permits insured state banks to invest in life insurance

policies or annuity contracts. If an application or some other type of

approval from the state banking regulator is required, the state

banking regulator's approval or nonobjection should be referenced. A

copy of such approval or nonobjection letter should be attached to the

notice. The FDIC can not authorize insured state banks to invest in

life insurance policies or annuity contracts unless they are permitted

to do so under existing state law. For this reason it is important that

banks identify the relevant state statutes, regulations or other

provisions of law which permit them to engage in such activities.

Again, such information will greatly assist the FDIC regional offices

in reviewing and acting on the notices as expeditiously as possible.

(B)(7). A copy of the board of director's resolution authorizing

the filing of the notice. The notice should state that the bank's board

of directors have authorized the proposed investment in life insurance

policies or annuity contracts and authorized the filing of the notice

with the FDIC. A copy of the Board resolution(s) should be attached to

the notice.

Regulatory Flexibility Analysis

The Board of Directors has concluded after reviewing the proposed

regulation that the regulation, if adopted, will not impose a

significant economic hardship on small institutions. This proposal

simplifies and streamlines the timing and information small entities

must file to engage in profit-making activities thereby reducing their

regulatory burden. By expediting processing and allowing small entities

to engage in profit-making activities more quickly, small entities may

avoid lost opportunity costs. The Board of Directors therefore hereby

certifies pursuant to section 605 of the Regulatory Flexibility Act (5

U.S.C. 605) that the proposal, if adopted, will not have a significant

economic impact on a substantial number of small entities within the

meaning of the Regulatory Flexibility Act (5 U.S.C. 601 et. seq.).

List of Subjects in 12 CFR Part 362

Administrative practice and procedure, Authority delegations

(Government agencies), Bank deposit insurance, Banks, banking, Insured

depository institutions, Investments, Reporting and recordkeeping

requirements.

For the reasons set forth above, the FDIC hereby proposes to amend

12 CFR part 362 as follows.

PART 362--ACTIVITIES AND INVESTMENTS OF INSURED STATE BANKS

1. The authority citation for part 362 continues to read as

follows:

Authority: 12 U.S.C. 1816, 1818, 1819[Tenth], 1831a.

2. Section 362.4 is amended by adding new paragraphs (c)(3)(vi) and

(c)(3)(vii) to read as follows:

Sec. 362.4 Activities of insured state banks and their subsidiaries.

* * * * *

(c) * * *

(3) * * *

(vi) Equity interests in real estate. (A) An insured state bank may

invest in and/or retain equity interests in real estate through a

majority-owned subsidiary organized solely for such purpose provided

that the bank has filed written notice as described in paragraph

(c)(3)(vi)(B) of this section at least 60 days prior to making the

initial investment, the FDIC has not objected to the investment prior

to the expiration of the 60-day notice period nor extended the notice

period an additional 30 days and objected to the investment prior to

the expiration of the extended notice period, and the following

conditions are, and continue to be, met:

(1) The bank is well-capitalized as defined in part 325 of this

chapter exclusive of the bank's investment in the subsidiary as well as

any extensions of credit or commitments of credit to any third party

for the purpose of making a direct investment in the subsidiary or

making an investment in any investment in which the subsidiary has an

interest;

(2) The bank makes the deduction in paragraph (c)(3)(vi)(A)(1) of

this section for purposes of determining capital as reported on the

bank's report of condition and assessment risk classification purposes

in part 327 of this chapter and prompt corrective action purposes under

part 325 of this chapter provided, however, that the deduction shall

not be used for the purposes of determining whether the bank is

``critically undercapitalized'' as defined under part 325 of this

chapter;

[[Page 43499]]

(3) The bank's most current composite rating assigned by the FDIC

under the Uniform Financial Institutions Rating System or such other

comparable rating system as may be adopted by the FDIC in the future is

1 or 2;

(4) The subsidiary meets the definition of ``bona fide subsidiary''

as contained in Sec. 362.2(d) except that the requirements of

Sec. 362.2(d)(6) and (d)(7) are waived provided that the subsidiary has

at least one director who is knowledgeable with respect to real estate

investment activities and is not an employee, officer or director of

the bank;

(5) The subsidiary is managed by persons who have expertise in the

real estate investment activities conducted by the subsidiary;

(6) The subsidiary has a written business plan regarding the real

estate investment activities;

(7) Transactions between the bank and the subsidiary comply with

the restrictions of sections 23A and 23B of the Federal Reserve Act (12

U.S.C. 371c and 371c-1) to the same extent as though the subsidiary

were an affiliate of the bank as the term affiliate is defined for the

purposes of section 23A and section 23B except that extensions of

credit made by the bank to finance sales of assets by the subsidiary to

third parties need not comply with the collateral requirements and

investment limitations of section 23A provided that such extensions of

credit are consistent with safe and sound banking practice, do not

involve more than the normal degree of risk of repayment, and are

extended on terms and under circumstances, including credit standards,

that are substantially the same, or at least as favorable to the bank,

as those prevailing at the time for comparable transactions;

(8) Neither the bank nor the subsidiary shall engage in any

transaction which requires a customer of either to buy any product or

use any service of either as a condition of entering into a

transaction; and

(9) Neither the bank nor the subsidiary engages in any transactions

(exclusive of those covered by Sec. 337.3 of this chapter) with

insiders of the bank as insider is defined in Federal Reserve Board

Regulation O (12 CFR 215.2(h)), which relate to the subsidiary's real

estate investment activities without the prior written consent of the

appropriate regional director for the Division of Supervision.

(B) Notice filed pursuant to paragraph (c)(3)(vi)(A) of this

section may be in letter form and should be filed with the regional

director for the Division of Supervision for the FDIC region in which

the bank's principal office is located. The regional office will send

written acknowledgment of receipt of a completed notice to the bank

which shall indicate the date after which the bank may initiate the

investment activities if the FDIC has neither objected to the notice

nor extended the notice period. The notice period will begin to run

from the date the acknowledgment is sent. If the notice period is

extended, the bank will be notified in writing and informed of the date

after which the bank may initiate the investment activities if the FDIC

does not object. Notices shall contain the following:

(1) A description of the real estate investment activities;

(2) A copy of the business plan concerning the real estate

investment activities;

(3) A description of the subsidiary's operations including a

discussion of management's expertise;

(4) The aggregate amount of the bank's investment in the subsidiary

as defined in Sec. 362.2(q), which does not include retained earnings,

and the bank's extensions of credit and commitments of credit to third

parties for the purpose of making a direct investment in the subsidiary

or making an investment in any investment in which the subsidiary has

an interest stated as a percentage of tier one capital;

(5) The bank's capital after adjustments are made for the

deductions described in paragraph (c)(3)(vi)(A)(1) of this section;

(6) A copy of the board of directors' resolution authorizing the

filing of the notice; and

(7) An identification of the relevant state statute, regulation or

other authority which authorizes the subsidiary to conduct real estate

investment activities.

(C) An insured state bank which falls out of compliance with any of

the eligibility conditions in paragraph (c)(3)(vi)(A) of this section

shall notify the FDIC regional office within 10 business days of

falling out of compliance. The FDIC regional office shall review the

notice and take such action as it deems necessary. Such actions may

include, but are not limited to, requiring the insured state bank to

file an application pursuant to paragraph (d) of this section,

requiring the submission of a capital restoration plan or requiring the

divestiture of such investment.

(vii) Life insurance policies and annuity contracts. (A) An insured

state bank may invest in and/or retain life insurance policies and

annuity contracts, either directly or indirectly through a majority-

owned subsidiary of the bank, provided that the bank has filed written

notice as described in paragraph (c)(3)(vii)(B) of this section at

least 60 days prior to making the initial investment, the FDIC has not

objected to the investment prior to the expiration of the 60-day notice

period nor extended the notice period an additional 30 days and

objected to the investment prior to the expiration of the extended

notice period, and the following conditions are, and continue to be,

met:

(1) The bank is well-capitalized as defined in part 325 of this

chapter;

(2) The bank's most current composite rating as assigned by the

FDIC under the Uniform Financial Institutions Rating System or such

other comparable rating system adopted by the FDIC in the future is at

least 3;

(3) The bank's total aggregate direct and indirect investment in

annuity contracts and life insurance policies which do not conform to

OCC Banking Circular 249 does not exceed 30% of the bank's tier one

capital;

(4) The bank's total aggregate direct and indirect investment in

all annuity contracts and life insurance policies (conforming and

nonconforming) is no greater than 50% of the bank's tier one capital

and the bank's total aggregate direct and indirect investment in all

annuity contracts and life insurance policies (conforming and

nonconforming) from the same issuer does not exceed 15% of the bank's

tier one capital;

(5) The issuer(s) of the life insurance policies and annuity

contracts (conforming and nonconforming) is (are) rated in the top two

rating categories by a nationally recognized rating service; and

(6) The bank's board of directors has procedures in place to

monitor the financial condition of the issuer(s) of the life insurance

policies and annuity contracts (conforming and nonconforming).

(B) Notice filed pursuant to paragraph (c)(3)(vii)(A) of this

section may be in letter form and should be filed with the regional

director for the Division of Supervision in the region in which the

bank's principal office is located. The regional office will send

written acknowledgment of receipt of a completed notice to the bank

which shall indicate the date after which the bank may initiate the

investment activities if the FDIC has neither objected to the notice

nor extended the notice period. The notice period will begin to run

from the date the acknowledgment is sent. If the notice period is

extended, the bank will be notified in writing and informed of the

[[Page 43500]]

date after which the bank may initiate the investment activities if the

FDIC does not object. Notices shall contain the following:

(1) The aggregate amount of direct and indirect investment in

annuity contracts and nonconforming life insurance policies stated as a

percentage of the bank's tier one capital;

(2) The aggregate amount of direct and indirect investment in all

annuity contracts and life insurance policies (conforming and

nonconforming) stated as a percentage of the bank's tier one capital;

(3) The aggregate amount of direct and indirect investment in all

annuity contracts and life insurance policies (conforming and

nonconforming) from any one issuer stated as a percentage of the bank's

tier one capital;

(4) The rating of the issuer(s) of the policies and annuity

contracts;

(5) A description of the bank's monitoring procedures;

(6) The state statute, regulations or other authority which

authorizes the bank to make the investment; and

(7) A copy of the board of directors' resolution authorizing the

filing of the notice.

(C) An insured state bank which falls out of compliance with any of

the eligibility conditions in paragraph (c)(3)(vii)(A) of this section

shall notify the FDIC regional office within 10 business days of

falling out of compliance. The FDIC regional office shall review the

notice and take such action as it deems necessary. Such actions may

include, but are not limited to, requiring the insured state bank to

file an application pursuant to paragraph (d) of this section,

requiring the submission of a capital restoration plan or requiring the

divestiture of such investment.

Sec. 362.6 [Amended]

3. Section 362.6 is amended by adding ``the authority to act on

notices filed pursuant to Sec. 362.4(c)(3)(vi) (A) and (C) and

Sec. 362.4(c)(3)(vii) (A) and (C); the authority to rescind orders

issued pursuant to Sec. 362.4 where it is determined that the

institution is eligible to engage in activities pursuant to an

exception contained in Sec. 362.4(c)(3);'' immediately after

``Sec. 362.3(d);''.

By Order of the Board of Directors.

Dated at Washington, D.C., this 13th day of August, 1996.

Federal Deposit Insurance Corporation.

Jerry L. Langley,

Executive Secretary.

[FR Doc. 96-21475 Filed 8-22-96; 8:45 am]

BILLING CODE 6714-01-P