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FEDERAL RESERVE BANK OF NEW YORK r Circular No. 7 4 3 August 12, 1974 8*1 J Transactions Between Member State Banks and Their Affiliates T o A ll State M em ber Banks in the Second Federal R eserve D istrict: Following- is the text of an interpretation of section 23A of the Federal Reserve Act issued August 2 by the Board of Governors of the Federal Reserve System, which will be published shortly in the Federal Register and in the September 1974 Federal Reserve Bulletin : § 250.250 A p p lic a b ility o f section 23A o f th e F e d era l R eserve A ct to a m e m b e r State b a n k ’s p u rchase o f, or p a rticip a tio n in, a loa n orig in a ted b y a m ortga ge b a n k in g affiliate. (a ) A question has been raised as to w hether a mem ber bank’s purchase, without recourse, and at face value, o f any m ortgage note, diary o f its parent bank holding com pany a “ loan” or “ extension o f credit” from section 2 3 A of the Federal R eserve A ct or participation therein, from a m ortgage banking subsi at the inception o f the underlying m ortgage loan involves the m em ber bank to the affiliate within the meaning of (1 2 U .S .C . 3 7 1 c). In the given circumstances, the affili ate originated the m ortgage loans at premises other than an office o f the mem ber bank and hence was not a com pany furnishing services to or perform ing services fo r the holding com pany or its banking subsidiaries within the m eaning of § 4 ( c ) ( 1 ) ( C ) o f the Bank H old in g Com pany A ct (1 2 U .S .C . 1 8 4 3 (c ) ( 1 ) ( C ) L o a n s or extensions of credit to the affiliate were therefore not entitled to exem ption from the provisions of section 2 3 A by virtue o f subsection ( 1 ) o f the final paragraph thereof. (b ) Paragraph 4 of section 23A provides that the term “ extension o f credit” shall be deemed to “ include” the discount o f prom issory notes, bills o f exchange, conditional sales contracts; or similar paper, whether with or without recourse, excepting the acquisition o f such paper by a member bank from another bank w ithout recourse. In previously interpreting the statutory provision from which this provision is derived (S ection 6 o f the Bank H old in g Com pany A ct of 1956, repealed July 1, 1 9 6 6 ), the B oard con clu ded that “ discount” statute meant “ purchase” and that the purchase of notes, bills of in the con text of the exchange, conditional sales contracts or similar paper from an affiliate was subject to the prohibitions o f the statute. (1 9 5 8 Federal R eserve Bulletin 2 6 0 .) Further, the B oard notes that the definition in section 2 3 A is illustrative rather than exclusive. T he B oard believes that the purposes o f section 23A justify a broad construction o f the definition o f “ extension o f credit” to include certain purchases o f obligations, even though the purchases are not made at a discount from face value. A bank’s financing o f the w orking capital needs o f a m ortgage banking affiliate may occu r through out right purchases o f obligations, and the types o f abuses with which section 2 3 A are likewise possible in such circumstances, since such transactions between result in an undue risk to the financial con dition o f the purchasing bank. is concerned affiliates could ( c ) T he B oard is o f the opinion that the purchase by a mem ber State bank o f a m ortgage note, or participation therein, from a m ortgage banking affiliate w ould involve a loan or exten sion o f credit to the affiliate if the latter had either made, or com m itted itself to make, the loan o r extension of credit evidenced by the note p rior to the time when the member bank first ob li gated itself, by com m itm ent or otherwise, to purchase the loan or a participation therein. H ow ever, (o v e r ) there w ould be no loan or extension of credit by the member bank to its m ortgage banking affiliate if the member bank’s com m itm ent to purchase the loan, or a participation therein, is obtained by the affiliate within the context o f a proposed transaction, or series o f proposed transactions, in anticipation of the affiliate’s com m itm ent to make such lo a n (s ), and is based upon the bank’s independent evaluation o f the credit worthiness of the m o r t g a g o r (s ). In these latter circumstances, the mem ber bank w ould be taking advantage o f an investment opportunity rather than being impelled by any im proper incentive to alleviate w orking capital needs of the affiliate that are directly attributable to excessive outstanding commitments. (d ) T h e B oard cautions, how ever, that it would regard a blanket advance comm itment by a member State bank to purchase from its m ortgage banking affiliate a stipulated amount of loans, or an amount thereof exceedin g defined credit lines o f the affiliate, that bears no ref erence to specific proposed transactions, as in volvin g an unsound banking practice, unless the com m itm ent is conditioned upon com pliance of loans made thereunder with the requirements o f section 23A . It w ould not suffice to con dition such a com m itm ent upon the bank’s ultimate approval of the credit standing o f the various m ortgagors. T hat blanket comm itment would have the inherent tendency, in the context of an affiliate relationship, to cause the bank to relax sound credit judgm ent concerning the individual loans involved when the affiliate was in need o f bank financing, thereby resulting in an inappropriate risk to the soundness o f the bank. Additional copies of this circular will be furnished upon request. A lfred H a y e s , President.