Transactions With Affiliates And Insiders

ManagementSection 380Certain subsidiaries of a savings association, however, are affiliates. Subsidiaries that are affiliatesinclude: An insured depository institution that is a subsidiary of the savings association. Please note however, thatseveral exemptions including the sister bank/savings association exemption, limit theapplication of the affiliates rules to transactions with these associations. A company that is also directly controlled by one or more affiliates (other than an insured depositoryinstitution affiliate) of the savings association. For example, if an association owns 50 percent ofthe voting shares of its subsidiary and its holding company owns the remaining shares, thesubsidiary would be treated as an affiliate. A company that is also directly controlled by a shareholder (or a group of shareholders) that alsocontrols the association. An employee stock option plan, trust, or similar organization that exists for the benefit of theshareholders, partners, members, or employees of the savings association or any of its affiliates. Any subsidiary that OTS determines to be an affiliate.You should be aware that Regulation W states that “financial subsidiaries” of member banks areaffiliates. (See 12 CFR § 223.3(p) for a definition of this term.) OTS determined that savingsassociations do not have financial subsidiaries.Control.A fundamental concept underlying the definition of affiliate is “control.” For the purposes of theaffiliates restrictions, a company or shareholder has control over another company if: The company or shareholder, directly or indirectly, or by acting through one or more otherpersons, owns, controls, or has the power to vote, 25 percent or more of any class of votingsecurities of the other company. The company or shareholder owns or controls 25 percent or more of the equity capital of theother company, unless the company or shareholder demonstrates to OTS that it does notcontrol the other company. The company or shareholder controls in any manner the election of the majority of thedirectors, trustees, or general partners (or individuals exercising similar functions). The OTS determines, after notice and opportunity for a hearing, that the company orshareholder, directly or indirectly, exercises a controlling influence over the management orpolicies of the other company.In determining whether a company controls another, you should apply the following rules:Office of Thrift SupervisionFebruary 2006Examination Handbook380.5

ManagementSection 380 A company controls securities, assets, or other ownership interests that are owned orcontrolled, directly or indirectly, by any subsidiary of the company. A company does not control another company by virtue of its ownership or control of shares ina fiduciary capacity, except as provided in the “companies under other common control”description above, or if the company owning or controlling shares is a business trust. A company or shareholder controls securities if it owns or controls instruments (includingoptions or warrants) that are convertible or exercisable into the securities at the option of theholder or owner, unless the company or shareholder demonstrates to OTS that it does notcontrol the security.Please note that OTS used to apply the definitions and rebuttable presumptions of control in 12CFR Part 574 to affiliate transactions. In 2003, OTS revised the affiliates rules to incorporate theconcepts described above, and to delete references to Part 574. The scope of “control” may bebroader or narrower under revised rule depending on the circumstances. If you have any questions,you should contact your regional counsel.Companies that are not considered to be affiliates. Notwithstanding the definitions of affiliatediscussed above, a company is not an affiliate if it meets any of the following criteria: The company engages solely in holding the premises of the savings association. The company engages solely in conducting a safe deposit business. The company engages solely in holding certain United State government securities. Control of the company is the result of the exercise of rights resulting from a bona fide debtpreviously contracted. Such entities, however, are not considered to be affiliates only for alimited period of time.Transactions with third parties. A transaction between an association and any person will betreated as a transaction with an affiliate if the proceeds of the transaction are used for the benefit of, ortransferred to, an affiliate. Under this “third partyattribution rule,” for example, a loan to an unaffiliatedA transaction between anthird party will be attributed to an affiliate if theassociation and a third party willindividual uses the funds to purchase an asset from anbe treated as a transaction withaffiliate.an affiliate if the proceeds of thetransaction are used for thebenefit of, or transferred to, anaffiliate.Certain third party transactions are exempt from most§ 23A restrictions. For example, if a third party uses ageneral purpose credit card issued by an association topurchase products and services from an affiliate, theassociation does not have to attribute the loan to the affiliate. To be a general purpose credit card, a380.6Examination HandbookFebruary 2006Office of Thrift Supervision

ManagementSection 380credit card must be widely accepted for the purchases of products and services by merchants that arenot affiliates, and purchases from affiliates must be less than 25 percent of the total value of productsand services purchased with the card by all cardholders (12 CFR § 223.16(c)(4)). These transactions aresubject to safety and soundness requirements under § 23A and market terms requirements under § 23B.Subject to certain conditions, OTS also does not apply the third-party attribution rule to the followingtransactions: Extensions of credit used to purchase assets through an affiliate that acts exclusively as an agentor broker in the transaction. Extensions of credit used to purchase securities through a security affiliate (that is, a registeredbroker-dealer) that acts exclusively as a riskless principal in the transaction. Brokerage commissions, agency fees, and riskless principal mark-ups in connection with theseagency and riskless principal transactions. Preexisting lines of credit used to purchase securities from or through securities affiliates.These transactions are subject to various conditions that are more fully described at 12 CFR § 223.16(b)and (c).Is the Transaction a “Covered Transaction?”Once you determine that a transaction is with an affiliate, you must determine if it is a coveredtransaction.Transactions that are subject to § 23A restrictions. If you answer “yes” to any of thefollowing questions, the transaction is a covered transaction and is subject to the standards in § 23A.Has the association made a loan or extension of credit to an affiliate? This category includes making or renewinga loan, granting a line of credit, or extending credit in any manner. Loans or extensions of creditinclude: Intraday credit. Leases that are the functional equivalent of a loan. Advances via an overdraft, cash item, or otherwise. The sale of Federal funds to an affiliate. The acquisition of a note or other obligation of an affiliate.Office of Thrift SupervisionFebruary 2006Examination Handbook380.7

ManagementSection 380 An increase in the amount, extension of maturity, or adjustment to material terms of anextension of credit. Other similar transactions.Certain less-obvious transactions may also constitute the equivalent of extensions of credit or othertypes of covered transactions. For example, intercompany payable/ receivable transactions, rentsubsidies, and use of the association’s personnel, premises, funds, or equipment without adequatecompensation. Generally, if the association conducts such transactions on an arms-length basis,consistent with how they conduct transactions with a nonaffiliated party, OTS does not considertransactions “de facto” extensions of credit or covered transactions. However, you should review allsuch transactions to determine whether § 23A applies and, if so, whether the association complies withthe applicable restrictions. You should also review the transactions for general safety and soundnessconcerns regardless of whether they are considered extensions of credit.Has the association purchased assets, including assets subject to recourse or a repurchase agreement, from an affiliate? Apurchase of assets means an acquisition of an asset in exchange for cash or any other consideration,including an assumption of liabilities. The merger of an affiliate into a savings association is a purchaseof assets if the association assumes any liabilities of the affiliate, or pays any other form ofconsideration in the transaction.Has the association accepted securities issued by an affiliate as collateral security for a loan or extension of credit to anyperson or company? Securities include, for example, stocks, bonds, debentures, notes, or similar obligations(including commercial paper).Has the association issued a guarantee, acceptance, or letter of credit on behalf of an affiliate? This category includes,for example, an endorsement or standby letter of credit on behalf of an affiliate, a confirmation of aletter of credit issued by an affiliate, and a cross-affiliate netting agreement. The category also includescredit derivatives that are the functional equivalent of a guarantee, such as credit derivatives between anassociation and a nonaffiliate in which the association protects the nonaffiliate from a default on, ordecline in value of, an obligation of an affiliate.1Please note that the definition of covered transaction under Regulation W also includes the purchase of,or investment in, securities issued by an affiliate. Section 11 of HOLA generally prohibits thesetransactions for savings associations. See the following discussion.Prohibited Transactions. For savings associations, § 11 of the HOLA prohibits two types ofcovered transactions. If you answer “yes” to either of the following questions, the transaction isprohibited.FRB has not yet determined whether other types of derivatives are covered transactions. If an association engages in suchtransactions with affiliates, however, it must establish policies and procedures to manage the credit exposures in a safe andsound manner. At a minimum, the policies and procedures must provide for monitoring and controlling the credit exposure(including imposing appropriate credit limits, mark to market requirements, and collateral requirements), and must ensurethat derivative transactions with affiliates comply with the market terms requirements of § 23B. See 12 CFR § 223.33.1380.8Examination HandbookFebruary 2006Office of Thrift Supervision

ManagementSection 380Has the association purchased or invested in securities issued by any affiliate, other than shares of a subsidiary? For thepurposes of this prohibition, a subsidiary includes a bank or savings association.Has the association made a loan or extension of credit to an affiliate that is engaged in any activity that is impermissiblefor a bank holding company?OTS does not generally apply the third-party attribution rule to the § 11 loan prohibition. Thus, we willnot prohibit a loan to a third party merely because proceeds are used for the benefit of, or transferredto, an affiliate that is engaged in nonbank holding company activities. However, if you determine that aloan to a third party is a prearranged step in a series of transactions designed to channel funds to suchan affiliate, or is otherwise designed to circumvent the loan prohibition, you may inform the associationthat the transaction is, in substance, a prohibited loan. You may direct the association to divest the loan,unwind the transaction, or take other appropriate action.Please note that OTS revised some long-standing interpretations of the § 11 loan prohibition in 2003.For example, OTS used to treat certain repurchaseagreements as prohibited loans. OTS now treatsOTS used to treat repurchaserepurchase agreements as asset purchases. While theseagreements as prohibited loans;transactions are no longer prohibited, they remain subjectwe now treat them as assetto §§ 23A and 23B restrictions. OTS also used to attributepurchases.activities of subsidiary companies to certain parentcompanies in determining whether the parent is engaged in impermissible bank holding companyactivities. OTS no longer attributes activities among affiliates.Is the Transaction Exempt?Regulation W exempts certain covered transactions from affiliate restrictions under § 23A. Payparticular attention to the scope of each exemption. All of the exemptions, for example, relieveassociations from complying with the quantitative limits and applicable collateral requirements. Allcovered transactions remain subject to the safety and soundness requirements. Depending on theexemption, however, the low-quality asset purchase restriction may or may not apply. Exemptions fromthe market terms requirements under § 23B also vary and are discussed separately below.The following transactions are exempt from the 10 and 20 percent quantitative limits on transactionswith affiliates and the collateral requirements. These transactions are subject to safety and soundnessrequirements and prohibitions on purchases of low-quality assets: Sister Bank/Savings Association Exemption. Transactions with an insured depository institution if: The savings association controls at least 80 percent of the voting securities of the depositoryinstitution; The depository institution controls at least 80 percent of the voting securities of the savingsassociation; orOffice of Thrift SupervisionFebruary 2006Examination Handbook380.9

ManagementSection 380 A company controls at least 80 percent of the voting securities of both institutions (12 CFR§ 223.41(a) and (b)). Purchases of nonrecourse loans from affiliated depository institutions. This exemption applies to allaffiliated insured depository institutions, including those that do not meet the 80 percentownership requirement for the sister bank/savings association exemption (12 CFR § 223.41(c)). Internal corporate reorganizations. Purchasing assets from an affiliate where the transaction is a partof an internal corporate reorganization of a holding company and involves the transfer of all, orsubstantially all, of the shares or assets of an affiliate or a division or department of an affiliate.This exception is subject to various requirements, including a prior written notice to OTS and alimitation on the amount of the transaction (12 CFR § 223.41(d)).2The following transactions are exempt from the 10 and 20 percent quantitative limits on transactionswith affiliates, collateral requirements, and the low quality asset purchase prohibition. Thesetransactions are subject to safety and soundness requirements and to other requirements contained inthe cited references to Regulation W: Correspondent banking. Making a deposit in an affiliated insured depository institution (or anaffiliated foreign bank) that represents an ongoing working balance maintained in the ordinarycourse of correspondent business (12 CFR § 223.42(a)). Uncollected items. Giving immediate credit to an affiliate for uncollected items received in theordinary course of business (12 CFR § 223.42(b)). Credit transaction secured by deposits or U.S. government securities. Engaging in a credit transaction withan affiliate to the extent that the transaction is and remains secured by any of the following: Obligations of the United States or its agencies. Obligations fully guaranteed as to principal and interest by the United States or its agencies. A segregated, earmarked deposit account with the savings association that is for the solepurpose of securing credit transactions between the savings association and its affiliates, andis identified as such.2 A related provision exempts mergers and acquisitions that are step transactions. In step transactions, the association ultimately intends toacquire the company, but for various reasons, another affiliate acquires the company before transferring to the association. To qualify forthe related exemption, the transaction must satisfy 12 CFR § 223.31(d). Unlike the internal corporate reorganization exemption, a steptransaction is not subject to the prohibition on the purchase of low-quality assets.380.10 Examination HandbookFebruary 2006Office of Thrift Supervision

ManagementSection 380If a loan is partially secured by collateral identified above, the portion of the loan that is secured bythe collateral is exempt. The amount beyond the collateral’s value is not exempt (12 CFR§ 223.42(c)). Purchase of securities of a servicing affiliate. Purchasing securities of any company that is engagedsolely in providing specified services, such as holding property used by the association,processing data, providing personnel services, performing accounting and auditing activities,and handling advertising and public relations (12 CFR § 223.42(d)). Purchase of certain liquid assets. Purchasing an asset having a readily identifiable and publiclyavailable market quotation if the asset is purchased at (or below) that market quotation. Anasset has a readily identifiable and publicly available market quotation if the asset’s price isquoted routinely in a widely disseminated publication that is readily available to the generalpublic, such as the Wall Street Journal (12 CFR § 223.42(e)). Purchase of certain marketable securities. Purchasing marketable securities from a securities affiliate(i.e., a registered broker-dealer). Among other requirements, the security must have a “readymarket,” may not be a low-quality asset, and must be eligible for purchase by a state memberbank. Additionally, the purchase may not occur during or within 30 days of an underwriting ifan affiliate is the underwriter, and the security’s price must be electronically quoted in real-timeby an unaffiliated quotation system (12 CFR § 223.42(f)). Purchase of municipal securities. Purchasing municipal securities from a securities affiliate (i.e., aregistered broker-dealer). Among other requirements, the security must have a rating if theissuance does not exceed 25 million and must be eligible for purchase by a state member bank.In addition, the securities price must be electronically quoted in real-time by an unaffiliatedquotation system, verified by reference to two or more actual, current price quotes fromunaffiliated broker-dealers, or verified by reference to a written summary provided by thesyndicate manager to syndicate members (12 CFR § 223.42(g)). Purchase of an extension of credit subject to a repurchase agreement. Purchasing an extension of creditfrom an affiliate that the savings association originated and sold to the affiliate subject to arepurchase agreement or with recourse (12 CFR § 223.42(h)). Purchase of assets by a newly formed savings association. Purchasing an asset from an affiliate, if OTSapproved the asset purchase in connection with its review of the formation of the savingsassociation (12 CFR § 223.42(i)). Transactions approved under the Bank Merger Act. Mergers or consolidations between a savingsassociation and an affiliated insured depository institution (or U.S. branch or agency of aforeign bank), and acquisitions of assets or assumptions of deposit liabilities by a savingsassociation from such entities, if the transaction was approved under the Bank Merger Act (12CFR § 223.42(j)).Office of Thrift SupervisionFebruary 2006Examination Handbook 380.11

Management Section 380Purchases of extensions of credit. Purchasing an extension of credit from an affiliate, on anonrecourse basis, if all of the following requirements are met: The affiliate must originate the extension of credit. The association must perform its own independent evaluation of the creditworthiness ofthe borrower before the affiliate makes or commits to make the extension of credit. The association must commit to purchase the extension of credit before the affiliate makesor commits to make the extension of credit

Affiliate relationships and transactions with insiders can significantly affect a savings association's operations and overall financial condition. Your review of these transactions is a critical component of savings association and holding company examinations. However, the rules on affiliate transactions and