Regulation O and a Loan to a Director’s Spouse

Issue/Inquiry

The Bank made a loan to the spouse of a member of the Bank’s Board of Directors. The director is not a co-borrower and the income of the director was not used in the underwriting for the approval process. Is this loan subject to Regulation O?

Response Summary

Ordinarily, a loan to the spouse of a director of a bank who is credit-worthy would not be covered by Regulation O, provided that the director received no direct benefit from the proceeds of the loan, and the spouse was not considered to be a principal shareholder or otherwise an insider of the Bank.

Response Detail

A loan to the spouse of an insider of a bank who is creditworthy would generally not be covered by Regulation O. Under certain circumstances, however, such a loan may be imputed to the insider, or the spouse may also be considered an insider, in which case the requirements of Regulation O would be applicable.

Regulation O governs “extensions of credit” to the “directors”, “executive officers”, and “principal shareholders” (collectively referred to as “Insiders”), and their “related interests” of a federally-regulated bank and its affiliates. 12 CFR §215.2(h).

The director of the Bank would therefore be an insider and subject to the requirements of Regulation O. The spouse of the director would not be a “related interest” of the director, however, since for the purposes of the regulation, this term is defined as a company or political or campaign committee that is controlled by that person, or a political or campaign committee that provides funds benefitting the insider. 12 CFR §215.2(n).

A question that should be asked is whether the spouse is a principal shareholder of the Bank. Under Regulation O, a “principal shareholder” is a person who – directly, indirectly, or in concert with another person – owns, controls, or has the power to vote more than 10 percent of any class of voting securities in the bank. Shares owned or controlled by a member of an individual’s immediate family are considered to be held by the individual. “Immediate family” includes the spouse, minor children of the individual, and adult children living at home. 12 CFR §215.2(m)(1).

In this case, if the spouse or director and any other member of the spouse’s immediate family own or control more than 10 percent of any class of voting securities in the Bank, then the spouse would be a principal shareholder of the Bank and, thus, an insider. As such, the extension of credit to the spouse would be governed by Regulation O.

Regulation O also has a “tangible economic benefit” rule, under which an extension of credit made to one person will be considered to have been made to an insider, to the extent that the proceeds are transferred to the insider or are used for the tangible economic benefit of the insider. In this case, if the director of the Bank received any portion of the proceeds of the loan to the director’s spouse or received a tangible economic benefit from the loan, then the loan would be subject to the requirements of Regulation O. 12 CFR §215.3(f).

A Federal Reserve Board staff opinion letter indicates that a loan to a business owned by the spouse of an executive officer would not be considered a loan covered by Regulation O to the extent that the spouse was credit-worthy, the executive officer received no direct benefit from the proceeds of the loan, and the loan was repaid from the separate income of the spouse. FRB Staff Opinion, 3-1081.1. The loan in question had been made in a community property state, where jointly held assets of the spouse and executive director would be subject to the legal obligation of a loan made to the spouse. The point of the opinion was to distinguish a loan made to a spouse who was credit-worthy from a loan made to an insider whose assets might be affected by the loan.

The underwriting of the Bank determined that the spouse was credit-worthy in the spouse’s own right, since the income of the director was not considered in the credit decision. Whether the director received a portion of the loan proceeds or a tangible economic benefit from the loan, and whether the spouse is a principal stockholder or otherwise an insider of the Bank, are questions of fact which must be determined in order to conclude whether the requirements of Regulation O are applicable to this loan.

This entry was posted on Monday, August 14th, 2017 at 1:34 pm.