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Appeal of Findings and Mandates of Supervisory Letter (First Quarter 2008)

Background

The board of directors of a community bank appealed the findings and mandates contained in a supervisory letter issued by their OCC supervisory office. Specific concerns involved a legal-lending-limit violation and risk controls on an individual borrowing relationship. The board requested the Ombudsman to issue a stay of the supervisory letter and to ultimately vacate the findings and mandates.

Discussion

The board of directors appealed the supervisory office's determination that the bank violated the legal-lending -limit statute involving an extension of credit to a used-automobile dealership. Specifically, the bank appealed the decision that the borrower did not qualify for the additional increase (10 percent) under 12 USC 84(c)(8)(A) and 12 CFR 32.3(b)(2)(i). The appeal indicates the additional increase under the legal-lending-limit statute should not be denied based on a borrower's inability to satisfy its recourse obligation. The appeal also asserts the supervisory office erroneously concluded the bank would be at risk of financial loss in the event the dealership was required to perform under its recourse agreement.

As a result of the finding of a legal-lending-limit violation, the bank was instructed to discontinue future funding of the dealer's indirect paper. Additionally, the bank was required to classify the credit relationship as substandard and to develop an adequate allowance for loan and lease loss reserve reflective of the relationship risk. The remaining appeal issues included inadequate risk controls in administering the credit relationship, vehicle title perfection, and consumer regulatory compliance.

The Ombudsman conducted a review of all the information submitted by the bank as well as the supporting information provided by the supervisory office in their response to the appeal. Discussions were held with bank management and OCC legal staffs to obtain and clarify perspectives regarding a legal-lending-limit violation. Additional conversations were held with bank supervision experts regarding the various risk issues identified.

The examination staff had cited the legal-lending-limit violation, because the borrower's deteriorated financial condition precluded the borrower from effectively performing under their guaranty or recourse agreement. Therefore, the borrower was limited to 15 percent of the bank capital and not entitled to the additional 10 percent under the consumer installment paper exception.

The Ombudsman focused primarily on the legal-lending-limit violation, as it was the most significant issue to bank management. The legal-lending-limit regulation provides that any borrower may borrow up to 15 percent of the bank's capital on a secured or unsecured basis. In addition, the regulation provides a consumer installment paper exception, which allows an additional 10 percent of capital (total of 25 percent) if the borrower transferring the paper provides an unconditional guaranty or a recourse agreement.

Conclusion

After reviewing the bank's individual installment sales contracts, the Ombudsman determined the bank did have a valid recourse agreement. Based on the regulation, the borrower is not required to demonstrate its creditworthiness or ability to perform on its recourse for defaulted paper. As a result, the borrower was eligible for the full 25 percent borrowing limit and there was no legal-lending-limit violation. The bank may continue to extend credit to the maximum allowed by the regulation.

The remaining risk issues and mandates represented safety and soundness issues, which were the subject of an ongoing examination and could not be addressed until the examination was concluded.